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The inequality of public sector, defined benefit pensions

The inequality of public sector, defined benefit pensions
Pexels/Anna Shvets

A colleague made a presentation recently, which covered the disparity between defined benefit and defined contribution pension arrangements.

He considered the differing treatment between the two, particularly with regard to the annual allowance and the lifetime allowance.

It is apparent when comparing DB and DC schemes, that there is significant advantage, and I personally think there is unacceptable inequality, in the treatment of the former over the latter.

One scenario covered in the presentation was of two directors of a company. One was a member of the DB scheme, due to the member's length of tenure, and the other a member of the DC scheme, having joined after the DB scheme was closed to new members. 

In this scenario, the presumption was that the funding level of both schemes was set at 10 per cent from the employee and 20 per cent from the employer; the pensionable salary was £180,000 with a non-pensionable bonus of £35,000; the first director had 21 years’ service at the end of the pension input period, and neither had any other source of income or pension arrangements.

Both retained the full AA, as they had threshold incomes of £197,000 (£215,000 - £18,000 (£180,000 x10 per cent)). However, the first director’s pension input amount was just £38,405, while the second’s was £54,000. 

So, the first director had a PIA of £15,595 less than the actual monetary amount, and unused AA of £1,595 to carry forward.

The second director exceeded the AA by £14,000, and without enough carry forward of unused AA would be subject to a tax charge of up to £6,300.

There are actually very few open DB schemes in the private sector any more, primarily because of the increasing liability of meeting the obligation to pay a guaranteed index-linked pension for the life of the member and any dependent survivors.

Yet it is still the accepted norm for public-sector pension schemes, with schemes remaining open to new members. 

The received wisdom is that the reason for maintaining DB arrangements for the public sector is the lower salaries on offer. Without getting into the politics of this, a quick search of average salaries across some public sector roles can quickly dispel this view.

In Q2 of 2021, the average salary in the UK was £26,266, whereas across several local authority roles I looked at, the average was around £34,000. In education, the median for a teacher is about £31,000, and for a lecturer the average is in the low £40,000s.

For 'leadership-group' teachers, the salary scale ranges from approximately £42,000 to in excess of £117,000, with slightly higher amounts for those in inner London.

Coincidentally, around the time of my colleague’s presentation, I happened to be catching up with a bit of reading and came across an article by John Ralfe, an independent pension consultant. 

By his estimates, the average cost of all UK public-sector pension schemes for 2021 was 63 per cent of salaries, with employee contributions averaging 8 per cent, and the balance of 55 per cent from the employer, who is ultimately the taxpayer.