The awfully smart and meticulous people over at FullFact have blogged about John Hutton's pension report, observing that Hutton is at pains to stress that public sector pensions are not gold-plated:

But it is wrong to say that public service pensions are gold‐plated.  The average pension paid to pensioner members is about £7,800 a year. About half of pensioners receive less than £5,600 a year. And 90% of pensioners receive less than £17,000 a year.  Although these figures are partly accounted for by part‐time or part‐career working these pensions provide a modest – not an excessive ‐ level of retirement income

I'm afraid Hutton is wrong.  And FullFact are welcome to check my workings on why I say he's wrong.

The point isn't the absolute level of pensions in payment, which are indeed low.  After all, plenty of private sector workers have appallingly low pensions too. What matters is the amounts they cost the employee to purchase.

We'll take as our base case an employee who earns £25,000 a year and earns a pension over 10 years.  We'll also make the following assumptions:

• Inflation: 0.0%
• Investment (real) return: 4.0%
• Annuity rate: 3.3% ¹
• Annual scheme costs: 0.5%

I've plugged these figures into a Google Spreadsheet, so if you don't like these assumptions you can change them and see what it does to the figures.

If our employee is in a typical public sector pension defined benefit scheme, such as the Teachers Pension Scheme, they will contribute 6.4% of their salary in return for 1/60th of their final salary for each year of work.  If they earn no pay rises over the 10 year period, they will earn a pension of £4,167 for their service. They will contribute £16,000 over their employment for this pension.

Compare this to an employee on NEST (scenario 1 in the spreadsheet).  They will contribute only £7,500, because contribution rates are lower.  But they also bear the administrative and scheme costs.  They also bear the risk of poor investment returns and inflation.  The NEST member will have a pension of less than £800 per annum to show for their ten years of service.  This is less than one fifth of the public sector worker's pension.  Do you still think public sector pensions are not gold-plated?

For another comparison, let's imagine another employee on a much better defined contribution plan.  I don't really have one to refer to, so I'll make one up: let's take the employee contribution to be the same as the Teachers Pension Scheme (6.4%) and let's make the employer contribution as double that (12.8%).  That's a pretty nice DC scheme, and is probably far better than most private sector workers get.

That scheme would give our employee a pension of under £2,000 per annum (scenario 2), still under half what the public secctor worker would get.  Do you still think public sector pensions are not gold-plated?

In order for our private sector worker to get the same pension as the public sector worker, they would have to contribute 28.8% of their salary over the period (scenario 3), or convince the employer to raise their contribution rate to 35.2% (scenario 6).  I don't think there's a single scheme in the history of defined contribution pensions that has ever seen an employer pay this sort of amount.  Do you still think public sector pensions are not gold-plated?

Unbelievably, it gets even worse when we add wage inflation.  This is because public sector final salary pensions are based, as they describe themselves, on the employee's final salary.  Defined contribution pensions are based only on the size of the accumulated pension pot on retirement, so a higher pension requires a bigger pot.  If we assume that our employee gets a wage increase of 3% (in real terms) per year, then they will retire on a salary of £32,600 for a defined benefit pension of £5,433 per annum.  Our defined contribution pension member would get a pension of only £2,184 per annum (scenario 4).  To get the same level of pension as the defined benefit plan from a defined contribution scheme, our employee would need to contribute 35% of his salary (scenario 5), or get the employer to contribute 41.4% (scenario 7).  Do you still think public sector pensions are not gold-plated?

A public sector worker getting a 3% wage increase per annum receives pension benefits from the government that are equivalent to £6.47 for every £1.00 contributed by the employee ².  The most generous defined contribution schemes pay no more than £2.00 for every £1.00.  On top of which, the private sector pension is not guaranteed - it's only as good as the insurance company behind it - whereas the public sector pension carries a cast-iron guarantee.

Do you still think public sector pensions are not gold-plated?

I mean, really?

It's absolutely essential that something is now done to fix this chronic unfairness in the pensions system.

People who read this post also read:

• Eoinomics and teachers’ pensions
• Pensions justice, but only if you work in the public sector
• A tale of two employees
• Dude, where’s my pension?
• The TUC’s Nigel Stanley on pensions tax relief

Filed under: Current issues, Economics with tags defined benefit, full fact, lord hutton, pensions, public sector, the decline of pensions