Pensions: are private sector workers hard done by?
The UK is fast heading into a two-tier pension system, with the widening gap between private and public sector pension provision putting the country at risk of social division and unrest.
Official data shows that the number of people saving for retirement through private sector final salary schemes has fallen by two million since 2000, with 100,000 schemes closing last year alone.
The figures also show that the number of private-sector workers with final salary schemes hit a record low of 2.6 million last year. Final salary schemes – also known as defined benefit occupational pensions – provide members with a pension based on their income rather than contributions and stockmarket performance.
The number of final salary schemes is likely to be even smaller than the new figures show, as there has been a large rise in the number of companies closing these schemes to new and existing members since the onset of the recession.
Just five years ago, around 40% of companies still offered final salary pensions to new employees. However, there are now just four FTSE 100 firms who do so - Shell, Tesco, Cadbury and Diageo.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says the rate at which private sector employers are closing final salary schemes is accelerating alarmingly fast – and adds that the problem is across the board, with even charities and unions closing their defined benefit pensions.
Earlier this year, PricewaterhouseCoopers predicted that 42% of final salary schemes currently still open to existing members will close over the next five years.
The Office for National Statistics (ONS), which produced the latest figures, says that last year there were an estimated 2.6 million people in private final salary schemes, down from 2.7 million in 2007.
At the end of 2008, there were only one million people in private final salary schemes that were still accepting new members.
According to consulting firm Watson Wyatt, only one in every 10 jobs in the private sector includes a final salary scheme, and this will fall to about one in every 25 jobs as people move on or retire.
It adds that the fall in membership of these schemes was actually fairly slow between 2007 and 2008, mainly because employers were content to let schemes “die of natural causes” by closing membership to new staff and letting turnover do the rest.
However, Rash Bhabra, head of corporate consulting at Watson Wyatt, warns the latest figures represent the “calm before the storm” as more companies are now moving existing members across to defined contribution pensions schemes, where the costs are fixed in advance.
Ros Altmann, an independent policy adviser and pensions expert, agrees that 2009 will see even more schemes closing in light of mounting deficits.
She is also concerned about the widening gap between pension provision in the private sector compared to the public sector. While final salary schemes are fast disappearing in the private sector, Altmann says pension coverage for public sector workers is improving, with 6.3 million workers in final salary schemes in 2008, up from 6.1 million the previous year.
“The credit crisis, quantitative easing and the sharp fall in interest rates have led to much larger pension fund deficits and more private sector scheme closures - how long can the public sector remain immune from such pressures?” she asks.
“The pension division continues to widen, with public sector workers building up vastly more generous pensions than those available to private sector workers. Taxpayers will be forced to fund these pensions in future, as no money has been set aside to pay for most of them. This could well lead to social unrest in future if it is not addressed.”
McPhail, meanwhile, says there needs to be an independent investigation into ‘gold-plated’ public sector pensions as well as government-funded state pensions.
“The growing divide between public and private sector pensions is socially divisive and isn’t tenable in the long term,” he adds. “Final salary pension deficits will, ultimately, be funded by the next generation of tax payers.”
For private sector workers, the future is increasingly defined contribution pensions, and McPhail says that for the majority of people, this type of retirement savings scheme is the future.
However, there has been a fall in employer contributions. The ONS reports that while membership of defined contribution schemes remains relatively stable, employer contributions fell from 15% to 14.6% between 2007 and 2008.
“Falling employer contributions need to be reversed as people aren’t saving enough as it is,” says McPhail.
Brendan Barber, general secretary of the Trade Union Congress, defends private employers' support for pension.
"Private sector employers are increasingly choosing [group personal pensions and stakeholder pensions that have employer contributions] in preference to trust-based occupational defined contribution schemes," he explains.
However, Barber admits that, with more than 60% of the private sector workforce not saving in an employer-supported pension, private sector employers are not doing enough to help their workers save for retirement.
There is, of course, also a responsibility on individuals to ensure they are saving enough in their pensions.
“People need to adjust their expectations of retirement, as they are currently unrealistic,” says McPhail. “The zenith of pension provision was probably around 2000 – we won’t get back there for a long time. The burden of saving for retirement falls on the individual – that’s not a judgment, it’s just the way things are now.”
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.