Public sector pensions

People who work in the public sector are offered the chance to join a pension scheme.  

Most public sector employees belong to a defined benefit (DB) scheme – that is, one that provides a guaranteed future income in retirement related to salary during working life.  

Some public sector workers belong to defined contribution (DC) schemes – that is, ones from which the pension income received depends on the amount of money contributed and the investment return earned on those contributions.  

Most public sector DB schemes are unfunded – that is, contributions paid by current employees and their employers go straight back to the exchequer and are effectively treated the same as general taxation in that year, with current retirees’ pensions paid by the exchequer like other current spending.  

Which public sector pensions are unfunded, and which are funded?

The four largest unfunded DB schemes are for NHS workers, teachers, civil servants and the armed forces.  

Only a small number of public sector schemes – most notably the local government pension scheme (LGPS) – are funded. Contributions made to the LGPS by local government employees and employers are paid into one of 86 separate funds (in England and Wales). This money is invested to earn a return, with the money then used in future to meet the promises for a guaranteed future income that have been made to scheme members.  

Similar sorts of DB scheme used to be common in the private sector but have been increasingly replaced with DC schemes.

How generous are public sector DB pension schemes?

The pension benefits received by members of unfunded DB schemes are currently based on a formula that depends on their number of years of scheme membership and their average salary while a member. Different schemes use slightly different formulas. For example, under the current Civil Service Pension Scheme, members will receive an income equal to 2.32% of earnings for every year worked. The schemes also offer other benefits, such as the ability to pass on your pension to a spouse when you die and to transfer some of your future pension to a lump-sum on retirement.

Prior to 2015, most public sector schemes calculated pension benefits based on final salary, rather than career average salary.  

The most straightforward measure of a pension scheme’s generosity is the level of employer contributions. IFS analysis in 2021 found that average employer contributions were three times higher in the public sector (18%) than in the private sector (6%). ⁹ https://ifs.org.uk/sites/default/files/2022-10/Public-spending-pay-and-pensions-R219.pdf

For DB pension schemes, however, pension contributions are only an estimate of what it could cost today to pay the income promised in the future. For unfunded public sector schemes, this estimate is based on a measure of expected future growth of GDP called the 'SCAPE' discount rate (Superannuation Contribution Adjusted for Past Experience). The idea is that higher than expected GDP and therefore a larger economy should mean higher tax revenue, making it easier to meet future liabilities: as a result, lower contributions will be needed – and vice versa. ¹⁰ https://ifs.org.uk/articles/reduced-discount-rate-public-sector-pensions-will-add-billions-employer-costs

How much do unfunded public sector pension schemes cost the government? 

The whole of government accounts reports £1.3tn of unfunded public sector pension liabilities, that is the pension benefits which the government has said it will pay in the future to members of unfunded DB schemes. This large figure is due to both the high number of public sector workers who are members of these schemes, and the substantial pension benefits these members are entitled to.  

In 2023/24, total employer and employee contributions to public sector pension schemes were £49.9bn, while total payments to current pensioners were £55.0bn, requiring a top-up of £5.1bn from general taxation to cover the outgoings. In the national accounts, contributions by current public sector workers are treated as paying for payments to current pensioners. In 2024, the OBR forecasted that this balance would move into a surplus of £3.9bn by 2029/30 – meaning current contributions would be higher than payments. 

Are public sector pensions sustainable in the long-term?

Concerns about the sustainability of unfunded public sector pensions are frequently raised. This concern was the impetus behind the 2011 public sector pensions commission led by Lord Hutton, former Labour secretary of state for work and pensions. Following this, the government adopted a number of reforms which were controversial with the workforce, such as uprating pension income by the consumer prices index (CPI) rather than the retail prices index (RPI) and switching to pension income being related to career average salary, rather than final salary.

The OBR now forecasts that the cost of public sector pension schemes will fall as a percentage of GDP over the next 50 years from 1.9% in 2023/24 to 1.4% by 2073/74. ¹² https://obr.uk/frs/fiscal-risks-and-sustainability-september-2024/