Public service pensions - what's boiling over and what's gone cold

30 September 2019

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In our May newsletter we highlighted a number of issues bubbling on the public sector pensions stove. This month we take a look under the saucepan lid to check on progress.

Teachers pensions contributions and independent schools

The new academic year is just starting for schools up and down the country, bringing with it the increase in employer pension contributions from 16.4% to 23.6% of teachers’ salaries. It’s a serious cost challenge for independent schools  that now have to find the money through an increase in parents’ fees or budget cuts elsewhere. This has led to many schools reviewing whether continuing participation in the Teachers’ Pension Scheme (TPS) remains appropriate. 

A consultation published on 9 September 2019 sets out proposals to allow independent schools in England and Wales to keep existing teachers in TPS while offering alternative pension provision to new teachers. Cost-savings for any school opting for a phased withdrawal will of course be a much slower burn. Scotland and Northern Ireland may similarly consult in future.

A freedom of information request made over the summer reveals that between 1 September 2018 and 25 July 2019, 62 schools in England and Wales have given notice of their intention to leave TPS. With over 2,000 independent schools in the UK, it’s likely that there’s a significant number of institutions still in need of professional advice on the options available to them should they decide that continuing participation in TPS  isn’t viable.

Should the consultation proposals be implemented, you may also wish to revisit the issue with any client schools that had previously decided to retain TPS membership in case the possibility of a phased withdrawal changes the position.

Transitional protections

On 27 June 2019, the Supreme Court denied the Government permission to appeal the judgement that “transitional protection” afforded to older members’ of the firefighters’ and judicial pension schemes amounted to age discrimination. This protection allowed those closest to retirement to remain in their respective final salary scheme while younger members were moved to career average arrangements. 

Similar provisions exist across all major public service pension schemes and in a written statement of 15 July 2019, the Government accepted that it would therefore need to remedy the situation across the sector.   The eventual fix for the firefighters’ and judicial schemes will need to satisfy the employment tribunal and it seems unlikely that Government would want to steer a different course for the other schemes.

Despite recent legal posturing, this may mean that further litigation to achieve equality of treatment is unnecessary.  It’s also worth noting that not all younger public sector workers will have lost out as a result of the move to career average arrangements. In fact, the wider membership may end up paying for the estimated £4billion a year cost of putting things right through wider adjustments to contributions or benefits. 

Survivor benefits

In May, we highlighted that any pension pay-out to the surviving adult of a deceased public service pension scheme member can still depend on the survivor’s status and circumstances. Factors which can impact eligibility and pay-out include:

  • If the couple was co-habiting
  • If they were married or in a civil partnership
  • The age difference between the couple
  • If the surviving partner remarries or co-habits again.

On 4 July 2019, the Government provided its long-awaited response to the 2014 DWP/HMT Review on the differences in survivor benefits in occupational pension schemes. The differences revealed by the review reflect changing social behaviours and the introduction of new types of legal relationships.  Significantly, they also reflect the fact that changes have generally been applied prospectively to benefits built up from the point of change only.

The Government has now confirmed that it doesn’t intend to make any further retrospective changes to equalise treatment beyond those required by the Walker judgement. In particular, this means that pensions payable to cohabitees and to male survivors of mixed sex marriages could be calculated on a more limited period of membership than those payable to widows. So you should consider checking individual scheme rules where the surviving adult pension is a significant part of planning.

Doctors and the tapered annual allowance

Since our May newsletter, the Government has  launched two separate consultations on the introduction of measures intended to help doctors manage pensions tax liabilities by allowing them greater flexibility over the rate at which their NHS pension builds up. 

The most recent consultation published on 11 September goes much further than the so-called 50:50 option which the previous iteration introduced.  It sets out a number of proposals which the Government anticipates implementing for 2020/21:

  1. Clinicians will be able to self-determine their contribution and accrual rate at the start of the scheme year (1 April) in 10% increments and subject to a minimum member contribution of 10%. For example, they could choose to pay 30% of the standard contribution in exchange for 30% of the standard accrual rate or 70% of the standard contribution in exchange for 70% accrual. They will then be able to adjust their chosen rate towards the end of the year when they have a clearer line of sight into their earnings for the year with the changed accrual/contribution rate applying with retrospective effect to the start of the scheme year. Ancillary benefits such as death in service life cover will continue to be calculated as for “full” members. 
  2. Where a member makes a reduced accrual election employers will be allowed discretion  to use the value of their unused contributions to top-up the member’s pay as an end of year lump sum payment.
  3. In order to help mitigate against annual allowances charges arising from significant spikes in pay, the Government proposes to allow senior clinicians the option of phasing in the “pensionability” of large pay increases (e.g. over a three year period) where specified pay and increase criteria are exceeded.
  4. A new modeller will be commissioned to “help individuals assess options for using these flexibilities tailored to their personal circumstances”.
  5. Changes will be made to the operation of “scheme pays” under the NHS scheme. Although the impact is broadly actuarially neutral for members, the changed methodology is intended to provide greater clarity on how the individual’s pension is impacted. Further information on how “scheme pays” operates and the proposed change is provided below.

Scheme pays currently operates rather like a loan.  NHS pensions applies compound interest to the amount of the charge it pays on the member’s behalf, and the accumulated total is converted into a pension amount which is deducted from the member’s pension when they retire. The interest rate applied to the scheme pays ‘loan’ is the scheme discount rate which is currently the SCAPE discount rate (2.4%) plus CPI (currently also 2.4%).  The effect this has on an individual’s pension entitlement causes a good deal of confusion so we’ve set out an example of how this works in practice below.

Meet Sophie

Sophie is a 50-year old senior clinician with pensionable pay of £142,000 for both 2018/19 and 2019/20. She has 20 years’ service in the 1995 section and 4 years’ service in the 2015 scheme. Her earnings from private practice and investments together with the value of her employer’s contribution cause the adjusted income to exceed £210,000 in 2019/20 giving her a tapered annual allowance of £10,000 and a tax charge on input to the 2015 scheme of £14,075.

The effect of a scheme pays election on retirement at age 60 will be as follows:

Charge

£14,075

Charge + 10 years’ compound interest

£14,075 * 1.048 (10) = £22,493.7

Conversion Factor at age 60 (normal health)

20.90

Pension Debit at age 60

£22,493.7 /20.90 = £1,076.25

Pension accrued in 19/20

£142,000/54 = £2,629.63

Value of 19/20 pension at age 60 (CPI + 1.5%)

£2,629.63 * 1.039 (10) = £3,855.23

Actuarial Reduction factor for early payment by 7 years

0.70

Actuarially Reduced Pension

£3,855.23 * 0.70 = £2,698.66

Net Pension After Reduction and Scheme Pays debit

£2,698.66 - £1,076.25 = £1,622.41

Notes: Scheme pays factors are applied after any actuarial reduction
Above assumes no changes to SCAPE discount rate of 2.4% and no change to CPI of 2.4%
Sophie has a state pension age of 67
Under a fully accurate calculation interest at SCAPE + CPI is added from January following the scheme pays election

In our example, by staying in the scheme and paying the charge through scheme pays, Sophie will build up additional net pension rights of £1,622.41 at her preferred early retirement age of 60. Following retirement, this pension will be paid each year for the rest of her life and will increase by CPI. Cutting the cookie a different way,  in exchange for NHS Pensions paying her £14,075 tax charge Sophie will receive £1,076.25 less pension each year than she would if she paid the charge from her own funds. 

The previously proposed change in methodology would bring NHS pensions in line with the other public service pension schemes, which operate scheme pays as a simple pension debit in the year the scheme pays the charge.   

Over and above these proposals, the Government has reiterated its commitment that the Treasury will “review how the tapered annual allowance operates in order to support the delivery of public services”. It’s also said that if any changes to the tax system are introduced, the need for flexibility in the NHS Pension Scheme “may” be revisited.  If you’re a ‘cup half full’ type, the doctors’ pension crisis could turn out to be the catalyst for abandoning the tapered annual allowance altogether. For those with a less positive outlook, it could potentially mean differentiated tax treatment for some or all public servants or no change to the status quo at all.   

Whatever happens, unless and until there’s a change in the pensions tax system and/or the new proposals are implemented, advisers working in this space (and in particular those potentially giving opt-out advice) should ensure they understand the relevant employer’s approach following publication of interim Government guidance on possible local approaches.  These include the option of recycling unused employer contributions as extra salary.

About the author

Moira Warner

Senior Business Development Manager

Moira spent the early part of her career with a number of European investment banks both here in the UK and overseas with responsibility for sales of money market securities and fixed income products to institutional and Central Bank clients. In the early noughties she moved to the life insurance sector where she has held various pensions technical roles supporting both provider product and proposition/ sales. Moira specialises in Public Sector pensions and worked closely with a number of key Public service pension schemes and the Local Government Association to help ensure the compliant overlay of pension freedoms on scheme regulations and practices.

Last updated: 17 Oct 2019

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