The beginning of a new era of pensions inequality

Inflation has driven a wedge between retirement savers. By Lauren Almeida

Retired public sector workers are to be handed their biggest pay rise in decades while pensioners who worked in the private sector see their real income eaten up by inflation.

Public service pensions will rise by 10.1pc next April in line with inflation figures published last week. The increase will cost taxpayers at least £19bn over the next 20 years. It comes as private company pension savings that offer no protection against inflation have been devalued by rocketing prices and struggling stock markets.

The disparity has triggered calls for an overhaul of public sector pensions to ensure they are affordable for an increasingly strained public purse.

Taxpayers will have to pay as much as £4.5bn to cover the cost of honouring “gold-plated” public sector pensions next spring, according to estimates from Canada Life, the pensions firm. The Government is legally bound to increase former public servants’ retirement income each year in line with September’s inflation figure, which hit a 40-year high.

It means the Treasury will have to spend an extra £3bn in pension increases across just four of the largest schemes – the NHS, teachers, the Armed Forces and the civil service – according to estimates from the wealth manager RBC Brewin Dolphin.

Over the next 20 years the inflation link will cost taxpayers an estimated £19bn, assuming that inflation returns to normal levels by 2024, based on calculations from Canada Life.

Connor MacDonald of the think tank Policy Exchange said: “As the private sector moves to phase out defined benefit pensions and turns to defined contribution, it is fair to ask if the demands placed on the taxpayer by public sector pensions are sustainable. The Government could consider a shift to defined contribution, though this would be a less generous option. In any case, there is a strong argument for reform.”

The generosity of public sector pensions used to be compensation for lower salaries. However, this gap has been narrowing. The average private sector worker earned £622 a week in the year to August, according to IDR, an analyst. The average public sector worker, excluding those who worked in finance, earned £593.

Former public servants will also enjoy two layers of taxpayer-funded protection from inflation next year, assuming the state pension “triple lock” is upheld. The policy promises to increase the state pension every April in line with the highest of the previous September’s inflation, wage growth or 2.5pc.

Millions of savers who rely on “defined contribution” pensions – which invest your pot of savings over the course of your working life – are much more vulnerable to the double whammy of inflation and volatile stock markets, experts have warned. The average private pension of £9,724 a year will lose almost £500 of its purchasing power over the next 12 months, even when assuming a moderate level of investment growth.

Carla Morris of RBC Brewin Dolphin said the lack of inflation protection built into private pensions was creating a gap between public and private sector workers’ retirement prospects. She said: “Private sector workers will have to take on a level of investment risk that previous generations did not have to.”

Baroness Ros Altmann, a former pensions minister, warned that the inflation link in public sector pensions was written into law and “cannot be changed just at the whim of a government”.

She said: “It is absolutely vital that all state pensioners who do not have the benefit of a public sector pension should be protected at least as well as those who have both the state pension and their additional public sector pensions.”

Former public servants are also better protected from penalties that arise from the lifetime allowance on pension savings. This is the amount that savers can accrue tax-free over their lifetime and has been frozen at £1.073m until the 2025-26 tax year.

For savers in defined contribution pensions, the limit applies to the value of your invested pot. However, for members of public sector schemes, the value is typically calculated by multiplying their expected annual pension by 20.

This means that a retired public sector worker can have a retirement income of £53,655 without hitting the cap, while a private sector worker with a pension at the cap would receive an income of £50,436 if they were to buy an annuity. Above this level, they would be taxed at a rate of up to 55pc.

‘Private sector workers will have to take on a level of risk previous generations did not face’