ANDY GADD
Head of Research
LighthouseGroup plc
Andy has worked in financial services for more than 25 years. He enjoys his current research function as the world of financial services is always changing. Outside of work, Andy enjoys walking his dog, playing golf (badly) and reading
The government-commissioned final report from the Independent Public Services Pension Commission, led by former Labour minister John Hutton, on the subject of the future of final salary pension schemes was published on 10 March this year.1 The 215-page report, and the government’s acceptance of Lord Hutton’s recommendations as a, basis for consultation with public sector workers could have a significant impact on some general practice staff.
If you are a member of the NHS Pension Scheme you can expect to see massive changes to your pension by 2015. As well as saying that you will have to work longer, the Hutton Report proposes that pensions should be calculated as a proportion of average salary over a career, rather than a final salary. In addition, the report also advocates that public sector workers personally pay more in to their pension scheme, with contributions potentially tiered according to the level of salary so that lower paid earners pay in less than higher-paid earners.
How will my NHS pension change?
Lord Hutton’s proposed changes are expected to come into force by the end of the current Parliament – ie, 2015. As stated, the biggest shift suggested is a move from public sector pensions being final salary schemes (which pay a percentage of final salary based on years of service) to career average schemes (based on average pay across your career).
As a simple example of this change, if an individual under the ‘old’ system had 20 years of qualifying service in the NHS scheme, with a 1/80th accrual rate, then if on retirement they were earning £20,000 a year they would be entitled to a pension of 20/80 of their final salary – ie, £5,000 a year. On a career average scheme, however, their salary for pension purposes would be the ‘average’ that they had earned over their career, rather than simply their final salary – ie, perhaps five years at £15,000, 10 years at £18,000 and five years at £20,000. The average salary using these figures is therefore £17,750, giving a final pension of 20/80 of this, or £4,437.50.
At this stage Lord Hutton has not recommended the exact shape of the future career average schemes – he has left that up to the government.
This proposed change would have the biggest impact on those public sector workers who start off as low earners and work their way up to be high earners across their career (this has already been implemented for anyone who joined the civil service after 2007). Lower-paid employees, and those whose salary stays relatively constant across their career, won’t feel much impact.
In addition to reflecting rising longevity, the Hutton report has proposed that the public sector retirement age should rise in line with the state pension age. If implemented, this will mean that, by 2020, most public sector staff (excluding the police, members of the armed forces and fire fighters) will retire at 66. Currently, for most public sector workers the retirement age is 60, although for some new recruits it is 65, in line with the private sector.
The report also proposes ways to cap the cost of public sector pensions with “automatic stabilisers”. These would mean that, as longevity in general increases, the pension age should either go up, or employee contributions should rise, or the accrual rate should slow.
How all this will affect individual pensions will really depend on individual circumstances, but a key point to note is that these changes aren’t proposed to be retrospective. All entitlements already accrued under the old scheme remain. So the closer someone is to retirement now, the less affected they will be. In other words, any pension already built up will still be linked to an individual’s final salary, but future pensions rights will accrue under the career average scheme.
Impact on GP practices
The Hutton report makes specific reference to GP practices. On page 116, it says the NHS Pension Scheme “includes more than 9,500 self-employed GP practices, with an average of eight members in the NHS scheme.”(1)
With reference to this access to the NHS scheme, the report goes on to say: “Given that the government is keen to extend alternative models of public service delivery, the issues related to public service pension scheme access are likely to be of relevance to an increasing number of people and organisations in the years ahead.”
It also states: “It is ultimately for the government to decide how much long-term pensions risk it is willing to bear in order to meet its wider policy objectives. However, it is clear that enabling access to public service pension schemes for non-public service workers does increase the long-term risk government bears in relation to those schemes.”
The specific recommendation is therefore that: “It is in principle undesirable for future non-public service workers to have access to public service pension schemes, given the increased long-term risk this places on the government and taxpayers.”
The crucial word in this sentence appears to be “future”, rather than “current”. My expectation, as with proposed amendments to the state universal pension, is that benefits accrued to date will be protected but benefits accrued from a future date (to be determined by the government) will be affected.
However, the report does go on to say that “the issues concerning access to public service pension schemes are complex and wide-ranging. Enabling access to public service pension schemes has clear pros and cons, and it will ultimately be for the government to consider how best to address these issues, in the light of its wider policy priorities.”(1) The government is due to set out proposals in the autumn.
As the Hutton report says that accrued benefits should be maintained on the ‘old’ system, those no longer members of the NHS scheme will not be affected by any changes introduced as a result of the report – but see below regarding the change from using RPI to CPI for inflation increases. There is no doubt, however, that as it stands there won’t be anybody who will be ‘better off’ as a result of the report, merely some that are less worse off than others.
Why are pensions being reformed?
The cost of public sector pensions is the main reason for the reform. Some analysts argue, however, that the cost is sustainable – they point to the fact that future costs are inherently uncertain and sensitive to assumptions on factors including life expectancy, size of workforce, earnings growth and the implementation of reforms. Some of these analysts even suggest that the cost of public sector pensions could actually fall as a proportion of GDP over the next 50 years.(1)
The costs of public sector pensions peak around about now at around 2% of GDP (£32bn a year), and then fall, to closer to 1.4% of GDP. (To put that in context, £32bn is roughly equivalent to the defence budget.) This reduction isn’t, however, primarily due to the projected Hutton reforms but is, in fact, due to two other major reforms set to be put in place.
The first is a shift to higher employee contributions. The average public sector worker will have to start increasing their contributions by three percentage points (for example, from 6% to 9%) on average by 2014/15, but this will vary across the board – it is estimated this will save around £2.8bn a year. This means, for example, that an individual earning £20,000 a year would have to contribute an extra £600 or £50 per month from their gross salary.
The other reform is moving from using the Retail Price Index (RPI) to the Consumer Price Index (CPI) for future pension increases. Both track the changing cost of a basket of goods and services, from food to travel fares, over the course of a year. The key difference between them is that RPI includes housing costs, such as council tax and mortgage repayments. This means that CPI is typically lower than RPI in the figures produced monthly by the Office for National Statistics.
RPI, which started in 1947, has historically been the favoured measure of inflation used by governments when calculating increases in pensions and various benefits each year. However, since its first ‘Emergency Budget’ in June 2010, the coalition government has been introducing CPI as its favoured inflation measure. It claims CPI, which the Bank of England uses for its inflation target, better reflects the costs incurred by the typical household.
At the time of writing, CPI inflation is currently 4% while RPI is 5.3%, and these are expected to fall to 2.5% and 3.6% from next year. But the difference between the two measures is expected to increase as interest rates rise. By 2015, RPI is forecast to be at 3.8%, which is forecast to be almost double the CPI rate of 2%. The change from RPI to CPI is estimated to save £6bn a year.
What should I do?
It is important to remember that your retirement planning does not have to be solely through a pension scheme but ultimately it’s best not to put your head in the sand and simply hope that everything will be all right, but instead take action to ensure you will have the retirement income you deserve.
Reference
1. HM Treasury. Independent Public Service Pensions Commission: Final Report. London: HM Treasury; 2011. Available from: http://www.hm-treasury.gov.uk/indreview_johnhutton_pensions.htm
