Confronting Inequality in the UK Pension System

In the previous article on the UK State Pension, Anthony Royd explored how the system places an unequal burden on low-income taxpayers through a funding structure that disproportionately benefits higher earners.

He highlighted the impact of means-tested benefits, which diminish as state pensions increase, and how rising income inequality among retirees exacerbates the financial pressure on younger workers tasked with supporting this system.

Additionally, health disparities affecting employment opportunities were examined, shedding light on the broader inequalities in pension provision.

This article shifts focus to explore three key aspects of the UK pension landscape identified in the opening article: the advantages of public sector pensions, including their government-backed security and benefits; the challenges of private sector pensions, marked by volatility and lower contributions; and the fairness of taxpayer contributions, questioning the ethical implications of the current funding disparities.

Public employees typically participate in two main types of pension schemes: the State Pension and occupational pension schemes, which can include Defined Benefit (DB) pensions that many public sector employees are enrolled in.

These promise a specific payout at retirement based on factors such as salary and years of service. These pensions are often more generous than private sector alternatives and provide financial security as they are calculated using a formula that considers an employee’s final salary or career average earnings.

Public sector pensions in the UK are often characterised by their security and stability, primarily due to government backing. These pensions typically operate on a defined benefit (DB) basis, meaning that retirees receive a guaranteed income based on their salary and years of service rather than relying on investment performance.

This structure provides a predictable retirement income, which is particularly advantageous for public sector employees.

The funding of public sector pensions is generally robust, supported by contributions from both employees and employers (the government). The government’s ability to raise taxes and borrow funds allows it to meet pension obligations even in times of economic downturns. For instance, the major public sector pension schemes include the following schemes.

NHS Pension Scheme

It is primarily funded through contributions from both employers (NHS trusts) and employees. The government provides additional funding to cover any shortfalls in the scheme’s finances, particularly as it relates to meeting its obligations to pensioners. As of 2023, the estimated annual cost of the NHS Pension Scheme is approximately £10 billion.

Teachers’ Pension Scheme. This is funded through contributions from teachers and their employers (local authorities or schools), with significant backing from government funding. The current annual cost of the Teachers’ Pension Scheme is estimated at around £8 billion.

This relies on contributions from civil servants and their departments. The government plays a crucial role in funding this scheme by providing financial support to meet future pension obligations. The annual cost for the Civil Service Pension Scheme is approximately £9 billion

While specific wage bills for each scheme aren’t publicly available, we can estimate costs using available data on proposed wage increases and published contribution percentages by salary range.

For the NHS and Teachers’ Pension Schemes, this approach allows us to approximate government contributions. The Civil Service lacks detailed figures, so we estimate its contribution based on the averages of the NHS and Teachers’ schemes.

I have highlighted three public sector pension schemes, with government contributions potentially exceeding £27 billion annually. In addition, there are approximately five main government pension schemes in the UK, including the Local Government Pension Scheme (LGPS) and the Armed Forces Pension Scheme, meaning the total cost is likely even higher.

A report published in The Telegraph claims that “taxpayers have been handed a £208bn public sector pensions bill because workers and employers haven’t paid enough in, analysis shows.” (Note: This figure has not yet been independently verified.)

If the reported £208 billion liability is accurate, it highlights significant structural problems within the UK’s public sector pension system. Insufficient contributions from both workers and employers point to systemic issues related to funding adequacy, demographic pressures, and policy effectiveness. Without meaningful reforms—such as adjustments to contribution levels or benefit structures—these challenges are likely to persist, threatening the long-term sustainability of public sector pensions

Without significant reforms and adjustments in contribution levels or benefits structures, these challenges are likely to persist, threatening the long-term viability of public sector pensions.

The LGPS, for instance, already faces funding challenges and may require central government support in cases of severe financial difficulty to ensure members’ promised benefits are upheld, regardless of market conditions.

Moreover, public sector pensions often include additional benefits, such as inflation protection through indexation, which safeguards purchasing power over time. This feature makes public sector pensions significantly more attractive compared to many private sector alternatives.

Private sector pensions primarily serve employees and small business owners and are typically structured as Defined Benefit or Defined Contribution schemes. However, unlike public sector pensions, private pensions often lack guarantees for minimum pay-outs or protection against inflation.

DB schemes can vary widely in terms of rules regarding early retirement or lump-sum payments upon leaving employment. While some plans allow members to transfer their benefits into other pension arrangements when changing jobs (though this may come with penalties), others may impose restrictions

However, in the private sector there has been a decline in DB Schemes. One primary reason for this decline is the financial burden that DB schemes place on employers. These plans require companies to make significant contributions to fund future liabilities. With increasing life expectancy and lower investment returns, many employers find it challenging to meet their obligations under these plans.

The aging population in the UK means that more individuals are drawing pensions than ever before, putting additional strain on existing DB funds. As more retirees begin receiving benefits without a corresponding increase in active contributors (younger employees), sustainability becomes a critical issue.

Employers are increasingly favouring Defined Contribution schemes (DC), because they offer more predictable costs and less long-term liability. DC schemes allow employees to take control over their retirement savings and investments, aligning with modern workforce expectations for flexibility and personal choice.

There is also a growing perception among younger workers that DC plans provide better opportunities for wealth accumulation through investment choices compared to traditional DB plans which may seem less transparent regarding future benefits.

Small business owners in the UK have several options regarding how they can manage their pensions

Most small business owners participate in defined contribution pension schemes where they can choose from a range of investment options. These options may include stocks, bonds (gilts), mutual funds, and other asset classes.

Many small business owners opt for SIPPs, which provide greater flexibility and control over investment choices. With a SIPP, individuals can invest in a wider array of assets beyond the options for DC schemes, including commercial property and individual stocks.

In contrast, private sector pensions face several challenges that can affect their reliability and adequacy for retirement. Many private pensions are structured as defined contribution (DC) plans, where the retirement income depends on the amount contributed and the performance of investments made with those contributions. This introduces significant volatility; if investments perform poorly, retirees may face reduced incomes.

Employer contributions to private sector pensions can also be lower than those in the public sector. While some companies offer matching contributions up to a certain percentage, many do not provide sufficient support to ensure adequate retirement savings for employees. Additionally, there has been a trend toward shifting pension responsibilities from employers to employees in recent years, leading to less secure retirement outcomes for workers.

Furthermore, private pensions often lack guarantees regarding minimum payouts or inflation protection. As a result, individuals may find themselves at risk of inadequate savings during retirement due to factors beyond their control.

The ethical question surrounding fairness arises when considering how public sector pensions are funded through taxpayer contributions while private sector workers may not have access to similar benefits.

Public sector employees often enjoy more generous pension schemes compared to their counterparts in the private sector.

This disparity raises concerns about equity among workers who contribute to funding these public pensions through taxes.

Critics argue that it is unfair for taxpayers—many of whom work in sectors with less favourable pension arrangements—to subsidise what can be seen as overly generous benefits for public servants.

This situation creates a divide between those who rely on taxpayer-funded pensions and those who must navigate potentially volatile private pension schemes without similar guarantees or support.

On the other hand, proponents of public sector pensions argue that they serve essential roles in attracting talent into public service roles that might otherwise struggle to compete with higher-paying private-sector jobs. They contend that well-funded public pensions contribute positively to society by ensuring financial security for retirees who have dedicated their careers to serving the community.

Historically this perception was based on the understanding that public sector employment provided additional benefits, such as job security and pensions, which compensated for lower wages.

However—Data from the Office for National Statistics (ONS) shows that public sector salaries often surpass private sector wages, especially in fields like healthcare, education, and technical roles. For example, NHS professionals typically receive higher total compensation than private sector counterparts, factoring in pensions and benefits.

Public sector pensions remain generous, but compensation packages now include competitive salaries, often matching or exceeding private sector offers. This undermines the argument that substantial pensions are essential merely to offset lower base pay.

To attract skilled workers in high-demand areas, public sector pay has risen, particularly in fields like IT and engineering. Such adjustments help public employers compete with private firms during labour shortages and increased demand.

Independent review bodies recommend salary adjustments for public sector roles, basing decisions on market comparisons to ensure competitive compensation and secure talent in essential services.

Rising inflation and living costs have driven public sector pay increases in recent years, aligning many public sector salaries more closely with those in the private sector to maintain competitiveness.

UK public sector pensions provide notable advantages, including security and government backing, but they also rely heavily on taxpayer funding. Given the potentially less secure alternatives available in the private sector, this system is not fair to the private sector and ethically unacceptable, or Is It Me!

The Triple Lock mechanism has been a cornerstone of the UK’s state pension policy since 2010, designed to ensure pensions rise annually by the highest of wage growth, inflation, or 2.5%. While its intention to safeguard retirees’ purchasing power is clear, the Triple Lock has sparked intense debate over its sustainability, intergenerational fairness, and economic impact.

In this article, Anthony Royd will explore the complexities of the Triple Lock system, examining its benefits and the criticisms it faces. How does it compare to pension models in other nations? Is it meeting its goals, or are there more effective alternatives to achieve pension adequacy while maintaining fiscal responsibility?

Join Anthony Royd, as we analyse the Triple Lock in the context of evolving economic conditions and international standards to determine whether it is the right tool for addressing the UK’s pension challenges.