Fairer Pensions

Inevitably, the Hutton report into public sector pensions has reccomended changes – the most notable being basing pensions on career average salary rather than final salary. This change is being presented in some quarters as ‘fair’ because the final salary scheme disproportionately benefits high-fliers. Aye, right.

I did a bit of number crunching and compared the pensions of “Jo” who does the same job for 40 years and “Angela who receives an increment of £1,000 per annum each year. Both start out at £20,000 p.a.

Under final salary, Jo retires after 40 years with a pension of £10,000 p.a., representing an income drop of 50%. In her final year, Angela is paid a salary of £59,000 and thus receives a pension of £29,500 (also a 50% income drop). Although her pension is triple Jo’s, her contributions over her working life are only double as they are a fixed proportion of salary. This does seem a little unfair and it would be reasonable to replace the fixed percentage contribution with a sliding scale so that Angela’s contributions over her lifetime were three times Jo’s.

On the face of it, the career-average salary basis also addresses this unfairness. Jo still gets a pension of £10,000 p.a. but Angela will get £19,750 which is proportional to her contributions but represents an income drop of almost 67%. This is presented as ‘fairer’ but Jo does not actully benefit one jot.

It gets worse. The above calculations do not take account of inflation. To do this I assumed an annual inflation rate of 3% and assumed cost of living rises matching it. Both of these assumptions are being generous as over the last 40 years inflation has often been greater than 3% (currently 4%, 8% in 1989, 25% in 1976) and cost-of-living rises have often been less than inflation. But let’s keep things simple.

Jo now has a final salary of £63,000 (but it buys no more than £20,000 did in year 1 when she started work). Her career average salary based pension is £19,000 – an income fall of almost 70%. It buys no more than £6,000 would have done in Year 1. Angela has a final salary of £187,000 (which buys the same as £59,000 would have done in Year 1. Her career-average salary based pension is £41,000 – representing an income drop of 78% and it buys no more than £13,000 would have done in Year 1.

At this point people will be pointing out that private sector schemes are now all like this. True but I do not see how cutting the pensions of former public sector workers benefits former private sector workers one jot. While small firms cannot afford final salary schemes, large corporations can – as witness they have retained them for directors. Thery have simply chosen not to pay them.

This bogus fairness issue will make the campaign to defend public sector pensions a hard sell. The unions need to make it a campaign to defend all pensions. The inevitable bleatings of private sector bosses can be circumvented by setting up a national investment based pension scheme with contributions on a sliding scale as mentioned above. They still won’y like it of course, because the Robert Maxwells of this world will no longer be able to raid pension schemes for their own use. It should suit everybody else as everybody, no matter where they work, will get a pension based on their final salary. Accrual for everybody will be 80ths as used in the calculations above. Of course that means MPs will lose their 40ths based pension.

I think I’ve just found an obstacle to implementation.

Tags: public sector pensions, retirement poverty