Hutton: The impact on public-sector pensions

The unions hate it, big business loves it...but the peer's report could change the lives of 12 million workers. What are their options?

The noise around Lord Hutton's public-sector pensions report was predictable: the unions hate it; the CBI loves it.

But, what will be the real impact on the 12 million public servants who have invested in the schemes? And are the recommendations radical enough to ensure that the taxpayer will be able to afford to fund their retirement in years to come?

John Wright, the head of public sector at the pensions specialists Hymans Robertson, thinks Lord Hutton has the balance right. "He had a near impossible task with so many different parties to appease: the unions, the workers, the Chancellor and taxpayer. But it's a well-judged report, with some good recommendations."

Lord Hutton recommends that public-sector workers should have access to their pensions at the same age as the state pension is due – currently 65 for men, with women's being gradually increased from 60 to 65 by 2018. Both will move on to 66 by 2020. For those in more physically demanding work – fire service police and armed forces, Hutton suggests the retirement age should increase from 55 to 60.

But Mr Wright warns that even raising the pension age in this way may not be enough to make the schemes affordable: "Bringing the pension age in line with the state pension is a good thing, but it has to be remembered that life expectancy is predicted to rise by two and half years a decade." Lord Hutton recommends a "safety valve" to prevent the state's contribution becoming too high, but negotiating a cap will be difficult and just as hard to implement, says Mr Wright. "Setting a cap relies on future projections which in turn rely on the assumptions you use. It will be difficult for the Government and unions to agree on those assumptions. Even if that is somehow negotiated, implementation will be hard and complicated."

Such problems have prompted some to suggest that the Hutton report is just a staging post: Laith Khalaf, a pensions analyst with IFA firm Hargreaves Lansdown, says: "I wouldn't rule out another review a few years down the line. We could move towards a defined contribution otherwise called money-purchase pension scheme. This is based purely on the amount paid into the scheme and its performance rather than carrying government-backed guarantees."

For the time being, Lord Hutton has ruled this out, preferring to move public-sector workers to a career-average, from final-salary, pension, but crucially retaining government guarantees on the value of the final pensions. The difference is in the way the pension is calculated on retirement, as a percentage of the salary you were earning at the point of retirement, or as a percentage of the average of all the pay received since joining the scheme. Both systems are classed as "defined benefits", rather than "defined contributions", in which the pension is based solely on the amount of money paid into a fund.

Most analysts seem to agree that this change will not drastically affect many pension holders and will benefit some. "Career average is still generous, certainly more so than most private-sector pension schemes. It is also fairer for the lower paid," says Mr Khalaf. "The only real issue is that Lord Hutton wants to link the pensions to average earnings, rather than the cost of living index, which will cost the Treasury more."

No one will lose any benefits they have built to date but the two schemes, final-salary and career-average, with their differing retirement ages, will run simultaneously. "It may be that you will end up with benefits that you can draw at two different points, one at 60 and the other a few years later," says Mr Khalaf. "I would expect there to be options to combine them at the later date as well."

But, according to Jason Witcombe, of Evolve, a chartered financial planner, even high-flyers with long service records and who, therefore, have most to lose should think carefully before doing anything rash, such as leaving their scheme.

"Anyone still being offered a defined-benefits scheme should bite off their employer's hand. Moving to career-average is a viable way to keep the schemes solvent. I would advise clients to go for a career-average scheme, rather than a defined-contribution scheme 10 times out of 10. The employer is taking all the risks, offering the pensioner a defined level of income, whatever happens in the economy. In all other stakeholder-type schemes, the risks are with the pensioner, whose benefits can fall if the stock market goes down just as they're about to retire."

Despite agreement that a career-average scheme is still a major benefit to public-sector workers, Mr Wright fears the biggest threat to the schemes' sustainability is workforce attitude. There have already been a significant number of opt-outs from all the funds. As wage freezes, cost-of-living rises, National Insurance increases and a 3 per cent rise in pension contributions have squeezed pay packets; often a pension is the first to go.

"There are grave concerns that the changes, if not properly communicated in a simplified way, will increase opt-outs. This will be a disaster, not only because they will become dependent on the state on retirement, but also because the funds will become unsustainable with fewer working members, and a whole lot more pensioners," says Mr Wright. "Hutton is right to emphasise the need for simplicity. It is up to employers and the Government to illustrate how much people will stand to lose by opting out, not least of which is the average £140,000 that employers contribute to a pension. In the end, effective communication could be the key to these pensions' survival."