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article imageOp-Ed: Defined benefit pensions – just for the public sector?

By Alan Cairns     Mar 13, 2014 in Business
London - Analysts estimate there will be no defined benefit (DB) pension schemes open to new FTSE 100 hires within the next decade. Meanwhile, in the public sector, DB pensions are still the norm. Why is this? And is it fair?
Analysts estimate there will be no defined benefit (DB) pension schemes open to new FTSE 100 hires within the next decade. As it stands, only 5 percent of new hires in the FTSE are offered pensions with at least a DB element. Only 1 percent are offered final salary schemes.
Meanwhile, in the public sector, DB pensions are still the norm. Why is this? And is it fair?
The end of final salary pensions
Final salary pensions — where an employee typically receives two-thirds of what their salary was when they retire — are on their last legs. Their rarity in the FTSE is a good indicator of what's happening in the rest of the private sector, but they are also closing in the public sector.
On the face of it, final salary pensions are nothing but reasonable. Two-thirds of your final salary for the rest of your life seems a pretty good way to spend your retirement. But they are expensive to run and faced with a combination of rising life expectancies and lower than expected gilt yields thanks to the financial crash, corporate pension bills have become unaffordable.
someone protesting about pensions
someone protesting about pensions
Wikimedia
The theory behind final salary pensions wasn't that the business would have to continually put money into the pension scheme once the employee had retired, but that the fund built up during employment would pay for itself. But with poor market performance companies are left to pick up the bill for the difference.
Why are defined benefit schemes closing?
The death knell is ringing for all private sector DB pensions as firms have become painfully aware of the consequences of making cast-iron promises for an uncertain future. When many companies are struggling to meet the cost of their existing pension bill it's understandable that they're no longer in the mood to make promises.
Replacement defined contribution (DC) pension schemes are much cheaper to run, both because they tend to have lower administration fees and because employer liability is much lower. Rather than signing up for a long-term commitment after the employee has left, they only contribute a fixed percentage of salary during employment and let investment performance and interest do the rest.
Them and us
Meanwhile, in the public sector, although final salary schemes are closing, under government reforms DB pensions will remain the norm — but based on average earnings rather than final.
This will significantly reduce the pensions bill for the state, especially when coupled with raising the retirement age, and drastically reduce the pension income for high-flyers in the public sector (though 'low-flyers' may be better off).
However, although the change undoubtedly makes public sector pensions more affordable, it still falls far short of the miserly condition of private sector pensions, leading to disgruntled accusations of 'gold plated' pensions from envious wage-slaves of industry. The government could further reduce their pension liability by following the FTSE's lead and switching exclusively to DC schemes whilst appeasing private sector discontents. So why don't they?
It's hard to say. But the most visible cause is the remaining strength of unions in the public sector. Every time a service's pensions are threatened, there's a strike. And though they may be grumbling about pension disparities, there will also always be a groundswell of public support for the people that teach our children, fight our fires and protect our streets.
There is also a strong argument that 'gold plated' pensions are necessary to attract talent to the public sector. Some comparisons show average public sector pay as higher than private, but there is also a disproportionate number of graduates and professionals who could earn more in the private sector — where upper earnings dwarf what's possible in the public sector.
Is it fair?
Collective bargaining and recruitment justification aside, that public sector pensions should be so much more generous than those received by the taxpayers that pay for them is quite rightly a source of frustration.
But as Barnett Waddingham pension consultant Malcolm McLean said in the Telegraph: “The contrast between the two sectors should not be used to justify draconian measures to deplete provision in the public sector, but instead to take all necessary steps to encourage and sustain more meaningful pensions in the private sector.”
To put it another way: although public sector DB pensions may seem unfair, does it really benefit anyone to have more poor pensioners than fewer?
The government seems sympathetic to this point of view. Coverage of the most recent announcements on pension reform have focused on the rolling back of legal obligations concerning final salary schemes in order to save the pensions of current members, but the proposed 'Dutch style' collective defined contribution schemes are far more interesting for the future.
It's claimed that the European style pensions — where employers band together to reduce costs, and payouts come directly from the fund rather than an annuity – could increase retirement incomes by 33 percent.
In the meantime, those not lucky enough to have a public sector pension would do well to save as much as they can themselves. According to Fidelity's pension calculator, a modest annual retirement income of £15,296 (basic cost of living, plus dining out every two weeks, plus theatre/concert tickets) requires savings of £922,000 over and above the state pension.
With so much uncertainty in both workplace and state pensions, it's well worth making private provisions to build that kind of nest egg.
This opinion article was written by an independent writer. The opinions and views expressed herein are those of the author and are not necessarily intended to reflect those of DigitalJournal.com
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