The state pension also needs reform

They are called ‘gold-plated’ but public sector pensions are in danger of losing their lustre and the Chancellor, George Osborne, has called them ‘unsustainable’. The Treasury has estimated the cost of public sector pensions for the current tax year at a staggering £25.4bn; that is £25.4bn the Government owes but does not currently have the funds for.


Where will the money come from? The former Labour Work and Pensions Secretary, John Hutton, is seeking answers to this question as the chair of the Independent Public Service Pensions Commission which will report preliminary findings this September.


We are in this mess because generations of politicians have avoided proper reform of public sector pensions because they feared it would cost votes. However, the dire state of the UK’s finances means the Government now has a once-in-a generation opportunity to make serious reform. There is broad consensus about how to do this, public sector workers need to work longer because of increasing life expectancy, and contribute more. It is not going to be popular, but it is the only realistic solution which is fair.


But there is another way to save the state money and make our pensions system more equitable – reforming the state pension. Currently, almost every citizen is eligible for a basic state pension upon retirement; a maximum of £97.65 a week for 2010/11. For millions, this is their main source of income in retirement and it is critical nothing endangers that.


But what about people whose pension, either from a private pension or public service pension, provides an annual retirement income that is greater than the national average wage e.g. a doctor or senior corporate manager?  Even with the death of generous private sector pensions, there is a generation who are retiring that are entitled to benefits that will be much greater than anything received by both past and future generations. They will collect a secure, and in many instances substantial income in retirement, with a large cash lump sum and £97.65 a week from the state. There are many in both the public and private sector in a situation like this.


Do they really need their state pension?


What if the £5,078 each would receive annually was not paid? This would start to reduce the burden of state pension provision and the cost to the taxpayer. The notion of the average public sector pension or the average private pension is misleading. There are many people in the private and public sector who will receive very generous benefits in retirement and simply do not need a state pension.  If this money were saved it could help provide better pensions for the poorest pensioners and those who have insufficient pensions from both the public and private sector.


This is controversial, but a serious debate is needed about whether the universal state pension is practical given the huge inequalities in earnings in this country. The system was originally set up as insurance against having no income in retirement.  Ironically, it now benefits those who need it the least – the affluent.


So who should be excluded from a state pension?  One benchmark could be if your pension entitlement is greater than the national average wage indexed to inflation, which was £25,428 in 2009, arguably you do not need your state pension. At the very least, this should be looked at closely.


Taking higher earners out of the state system would reduce the Government’s overall pension liability helping to balance the public finances while allowing assistance to be provided to those with the lowest retirement incomes. If changes along these lines were made, legislation would be necessary to prevent future governments tinkering further. A change so fundamental to a cornerstone of the British way of life can be made once, and only once.

As John Hutton considers his options, he should not be rushed into trying to find an answer to such a complex question in three months. Instead, he should consult actuaries, economists, accountants, academics and pensions companies extensively and begin a no-holds barred debate.


This is a golden opportunity to introduce real fairness and equality to the pension system and should not be missed.


Dr Iain Clacher, Leeds University Business School