Public sector pension reform may have been less prominent in the news since the day of action in June but this is just a temporary lull.
As we enter political conference season followed by scheme-by-scheme announcements of changes in October, we can expect a lot of noise on this issue. With the Government committed to making cost savings which will reach £2.8bn a year by 2014/15, there is the prospect of prolonged industrial action in the public sector in the coming months.
Many private sector workers will have little sympathy, arguing that public sector pensions are much more generous than theirs and will continue to be so even after the proposed changes. The Scottish Widows UK pensions report for 2011 found 65 per cent of public sector workers are preparing adequately for retirement, mostly through defined-benefit pensions, compared with 45 per cent in the private sector.
However, this is still a huge issue for those affected because they are being hit with three changes at once – higher retirement ages, higher contributions and perceived lower benefits, all on top of the existing reduction through the move from RPI to CPI.
The changes are being structured so they will have the smallest impact on lower-earners. This group’s contribution increases will be capped so they become less likely to lose out through the move from final-salary benefits to career-average revalued earnings pensions.
However, this means highearners are hit harder. For example, some NHS scheme members could see their contribution rate increased from 8.5 per cent to 14.5 per cent. Their pensions will be available later than at present and will also probably be reduced for not fully reflecting career progression.
Accrued benefits will be protected if and when the changes take place but many staff may consult advisers on whether they should opt out of the schemes for future service. As always, this is a decision which should only be made after very careful consideration.
One important issue is that if they remain active members, their benefits accrued before the change will still be on a final-salary basis, whereas if they leave it is likely that benefits will be based on their salary at the date of leaving increased with inflation. This could make a big difference.
If the increased contribution rate on a defined-benefit basis really is unaffordable, the adviser should consider whether the client should move to the defined-contribution section of the scheme and retain employer payments.
For many, particularly higher-earners, a major issue may be whether they should pay additional pension contributions if they can afford to. This would allow them to retire before the new final-salary scheme normal retirement age and compensate for a potentially reduced pension under career average.
The changes could reduce the value of pension benefits of someone working in the public sector throughout their career and with good career progression by as much as 30 per cent. This gives a clear opportunity for advisers and in-scheme AVCs should be considered alongside other options. It will also be important to ensure that the annual allowance is not exceeded by high-earners, although the carry-forward facility could help.
Public sector schemes will remain among the most generous available but it is important not to underestimate the impact on those affected. Advisers can play a key role in helping members manage their finances through the changes.
Ian Naismith is head of pensions market development at Scottish Widows