The widening chasm between public and private sector pensions

A huge gap is opening up in the retirement income people receive depending on whether they have worked in the public sector or for a private employer.

This gap is widening due to rampant inflation, which is boosting retirement income for former public sector employees.

Millions of retired teachers, doctors, civil servants and police officers received a record 10.1 percent increase in retirement income last month — and will receive another boost in April next year. Their gold-plated pensions rise with inflation.

In contrast, most people who rely on a private sector occupational pension have no such protection against the cost-of-living crisis. The amount of retirement income they receive has either stayed the same if it was tied to a flat annuity or has been jeopardized by poor stock market performance.

Exclusive analysis conducted for Money Mail by asset manager Quilter confirms the size of this gap. It reveals that for every £1 an employee saves into a pension, some gold-plated state-backed schemes pay six times as much pension income as the paltry private schemes.

Civil servants and local government employees are rewarded with the UK’s most gold-plated pension schemes, receiving a whopping £10.63 and £9.24 respectively in pension benefits for every £1 they save early in their careers.

By contrast, most workers on a typical private sector pension would be able to get just £1.75 for every £1 they set aside for retirement. Meanwhile, healthcare workers in the NHS receive £5.57 for every £1 they pay.

There is a myth that public sector workers receive more generous pensions in exchange for a lower salary. But that has not been the case for more than 15 years.

So many public sector workers enjoy a double boost: higher salaries when they work and better pensions when they retire.

Rebecca O’Connor, of the pension firm PensionBee, describes the gap as “pension apartheid.” She says, “I don’t think many of the people advocating for higher wages in the public sector know how generous the pensions they currently sit on are.”

She adds: ‘There is a huge pension inequality. Not only are private sector workers far behind when it comes to pensions, they also pay more taxes to fund some of these generous public sector pensions that promise the world.”

Mike Ambery, of retirement consultancy Hymans Robertson, agrees. He thinks it is unfair that the taxpayer should foot the bill for expensive government pensions.

He says, “It doesn’t seem fair at a time when inflation is high and people are finding it harder to cope.”

Official figures from the Office for National Statistics show that the average public sector worker received £595 a week last year – before tax. Meanwhile, private sector workers received just £517. That equates to an annual difference of £4,056.

Quilter’s calculations also show that teachers who save for teacher pensions will receive more than three times as much income when they retire than their private sector counterparts who paid the same amount.

Quilter’s analysis assumes that employees start saving early in their careers until they retire at the age specified in their retirement plan.

The figures also take into account tax deductions on pension savings, employer costs and investment returns.

Public sector plans, known as defined benefit pensions, promise to pay a guaranteed income that increases with inflation from the date you retire until the end of your life.

Usually, the amount you receive is linked to your final salary. But for civil servants, it’s tied to your average career salary. This inflation protection is more important than ever today, due to rising prices eroding the purchasing power of most household budgets.

Consumer price increases are expected to remain at 6.7 percent in September. It is this figure that will be used to determine the pension increase that retired public sector employees will receive from April.

These pensions are much more valuable than modern private sector schemes, which are designed on a defined contribution basis.

Such pensions are usually invested in the stock market and the pot of money is accessible at retirement, or even earlier (55 years). Employers are required to pay the equivalent of just 3 percent of their staff’s salary into these pension funds each year.

The responsibility for converting such a retirement plan into retirement income rests with the individual and not the company they work for, unlike with defined benefit plans.

Any income they receive is eroded by inflation, while an underperforming stock market has caused the average fund to lose money instead of growing over the past year.

Unless employees actively choose which funds to invest in, they will automatically be transferred to a pension that is suitable for all and chosen by their employer.

Many of Britain’s largest default pension funds have lost value this year as a result of violent market swings brought on by a toxic mix of rising interest rates, political uncertainty and skyrocketing inflation.

More than two million people whose employers use the standard fund from Now: Pensions, the UK’s third largest provider, have seen their pension schemes fall by 5.5 per cent over the past 12 months.

Five million savers whose companies use The People’s Pension default fund are down 2.5 percent.

Those retiring this year will need to find an extra £145,000 to match the same pension they could have afforded at the beginning of last year, according to calculations by asset manager Brewin Dolphin.

This is because out-of-control inflation is rapidly eroding the purchasing power of savings, while falling stock markets have wiped out thousands of pounds of the value of pension pots.

And those retiring this year risk lock-in losses they’ve incurred on their retirement investments and wipe out any hope of their fund’s recovery, said Kate Smith of pension group Aegon, who says: ” So much responsibility is piled on private sector workers to figure out how much their pension should be and whether they have enough to withstand inflation spikes or market downturns in retirement. Pension holders in the public sector do not have these concerns. In comparison, they have an easy life.

‘They know exactly at what age their retirement will start and they can be sure that they will not lose out due to inflation.’

Employees hoping for a comfortable retirement face a risky future ‘at best’, think tank the Institute for Fiscal Studies warned last month.

Nearly nine in ten middle earners in the private sector save less than 15 pc. of their salary — the amount previously recommended by the Government’s Pensions Commission to ensure a reasonable standard of living in retirement.

Ian Cook, financial planner at Quilter, did the pension calculations for Money Mail.

He says those who work in the private sector need to save more to make up for their worse pension plans.

He adds: ‘Those who have a defined contribution pension have to make sure that their payments work as hard as possible.

“This means taking an investment risk that is appropriate to your age – which is higher the younger you are – and that you don’t just accept the standard investment fund you’re in.”

The good news is that you can invest outside of the standard fund in almost all schemes. You can ask your employer, managers or provider for information about where you are invested and what other options you have. This information should also be available through your online retirement account.

But keep in mind the cost of the fund. Standard funds cannot charge more than 0.75 percent per annum, but others may charge more.

In the past, some private sector employers offered defined benefit plans, but most are now closed to new entrants and further contributions.

Even these pensions are less generous than their public sector equivalents. That’s because any inflation-related increases in retirement income are usually capped at a maximum of 5 percent.