Public sector pensions to be capped

Older worker

After years of tweaking and sometimes even raiding private sector pensions, the recession has finally prompted the chancellor to visit generous public sector pension pots in a bid to stem the UK’s mushrooming public debt.

In a surprise move, Alistair Darling revealed that among his cost-cutting measures in the public sector, pensions would not be immune from his "tough but necessary choices".

In his pre-Budget report, Darling pledged that contributions by the state to public sector pensions would be capped by 2012, saving around £1 billion a year. Public sector employees, especially those earning more than £100,000, would in turn contribute more.

"Public pensions need to be broadly in line with those offered in the private sector," Darling said.

The announcement comes after a long-running row over the imbalance between pension provision of public and private sector pensions.

The number of private sector final salary schemes that are open to new employees has fallen sharply over the past few years, while public sector workers continue to be offered gold-plated pensions.

A study by PricewaterhouseCoopers in August showed that employers would have to contribute up to 35% of a salary into an employee’s pension scheme to match a public sector pension.

Andrew Tully, senior pensions policy manager at Standard Life, welcomes the pre-Budget report announcement, saying it was inevitable as the government faced "spiralling public sector costs".

He adds that this is only the first step and we should expect more moves as costs are cut and public sector pensions begin to resemble their less generous private sector counterparts.

Darling said the move, which will affect teachers, local government, NHS and civil service workers, would help ensure NHS, school and police ‘front-line’ funding would be maintained. He predicted that it would save £1 billion a year from 2012-13, and at least £2 billion a year over the long-term.

In a not so surprising announcement, Darling unveiled some more meddling to private sector pensions.

April’s Budget limited the level of higher rate tax relief that people earning over £150,000 could receive on pension contributions from April 2011. Darling has now extended the impact to those earning a "gross" income of £150,000, with a floor of £130,000.

The change comes after the government finally worked out the definition of "relevant income". In simple terms, those with pre-tax incomes below £130,000 before the inclusion of employer pension contributions will not be affected.

Tully comments: "This is a very disappointing move, further breaking the long-standing principle that an individual receives tax relief on their pension contributions at their highest marginal rate.

"Continuous changes to pension tax rules do nothing to encourage saving, and we urge the government not to proceed with this move."

Tully recommends that people who earn over £130,000 should consider paying pension contributions of £20,000 this year and next (the highest amount as set by the government) to take advantage of higher rate relief while it’s still available.

Louise Somerset, tax director at RBC Wealth Management, was also dismayed by the news: "The government’s rhetoric for years has been to encourage people to save, but the incentives for doing so are being decreased.

"We know that the state cannot afford to pay for increasing numbers of retirees, so it doesn’t make sense to discourage us from saving for our pensions."

The switch from £150,000 to £130,000 could affect up to 150,000 additional people.

Meanwhile the basic state pension will increase by 2.5% in April next year, meaning a full basic state pension will increase by £2.40 to £97.65 a week.

The full couples’ rate will increase by £3.85 to £156.15 a week.