Lord Hutton has recommended reforming all three components of the public sector pension. He endorses increasing the amount scheme members will be expected to contribute (probably by three per cent), delaying the age at which employees can retire (in line with state pension age increases) and changing the base figure by which pension income is calculated, from final salary to career averaged salary. Plus, pension income is to be indexed in line with the Consumer Prices Index (CPI) measure of inflation, instead of the typically higher Retail Prices Index (RPI) measure.
These are major changes and pensions are certainly not the easiest of products to get to grips with anyway. Employees will need support and guidance from their employers over the coming weeks and years on how these reforms will personally affect them.
Effective communication is vital. For many people a pension is the biggest investment they will ever make in their lives, which means it's a highly emotive issue. Employers must be prepared to listen to questions from anxious and confused employees, and ease any concerns they may have.
In the first instance, many workers will want to know how moving from final salary to career average re-valued earnings (CARE) will affect them. Because the link to final salary is being retained, this change will have limited effect on people aged 50 or over. For others, it's worth pointing out that CARE is fairer; under final salary arrangements those who receive large pay rises a few years before retiring benefit far more than employees who maintain a steady salary throughout their working life.
Nevertheless, public sector workers will need to know what their options are going forward. Strike action aside, their only viable options are to accept whichever recommendations are agreed by the coalition or to opt out of the scheme offered to them.
Opting out will be tempting for some employees, especially if their budgets don't easily stretch to cover the contribution increase, but those who do so risk putting themselves in dire financial straits later on. It's crucial that assistance is provided on budget management to help people cope with losing more of their take-home pay in increased contributions.
Public sector pensions still offer a very generous income at retirement, even if all of Hutton's recommendations are accepted. It's therefore imperative employers avoid providing guidance on pensions as a standalone provision, but as part of a larger financial planning picture. This will ensure employees are able to make fully informed decisions about their own futures.
Public sector pension reform has been on the cards for a while now. In fact, delaying them has arguably caused a rift to develop between private sector and public workers. In the private sector, most final salary schemes have been closed to new members for years. Instead, employees have had to accept membership to a much less generous money purchase arrangement and the harsh reality that it's going to cost them a lot more to secure a comfortable retirement.
This realisation however, has forced private sector employees and employers to think much more strategically about pension provision. Employees have a better understanding about where their money goes and how much they need to contribute because their employer has improved communications and financial capabilities in this area. The public sector will need to address this capability gap amongst their employees going forward.
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Lord Hutton proposes that his recommendations are implemented by the end of this parliament: 2015. Surely it's no coincidence 2015 is also the year the National Employment Savings Trust (NEST) is expected to be fully implemented within the private sector. By then it's hoped practically every private sector worker will have at least 8% of their salary contributed into their pension scheme.
You don't need to read too far in between the lines to see that the government is pushing for every working adult - whichever sector they work in - to have their own pension provision in place as soon as feasibly possible. This will certainly reduce the burden on tomorrow's taxpayers but it does ring alarm bells. If we're all being encouraged to save for ourselves, can we expect the state pension to disappear in the near future, or be reduced to an insignificant sum? At the moment we just don't know.
But, given the tight time frames for change, this is an ideal opportunity for the public and private sector to work together, share knowledge and mend the rift that developed a few years ago.
Martin Osborne-Shaw, managing director of Killik Employee Services
