1st October 2022
general
One of the main advantages of working in the public sector is the pension. While the benefits have been cut back in recent years, a public sector pension still offers a better return on your contributions than a personal pension.
In this guide, we look at the main differences between public and private sector pensions.
Types of Scheme
Public sector pensions are available to anyone working in government, the NHS, the Civil Service, teaching, and many other professions.
Schemes have gone through a number of changes in recent years, and benefits can vary depending on your sector, region, and when you joined.
Earlier schemes were set up on a ‘final salary’ basis, which meant that your eventual pension would be based on your salary at retirement. In 2015, this changed to a ‘career average’ basis, whereby your pension would be based on your average earnings throughout your working life. In some cases this would result in a lower pension, particularly for employees who received significant promotions. Depending on when they started work, employees may have benefits based on final salary, career average, or both.
While some private companies have offered final salary pensions, the majority of these are now closed, although existing members retain their benefits in the scheme (unless they choose to transfer out). Most private sector pensions are now set up on a ‘money purchase’ basis, which means that you build up an investment pot to provide your retirement income.
Contributing to Your Pension
When you set up a pension through your workplace, you will normally have contributions deducted from your salary. These are taken from your gross pay, which means you don’t pay tax on the amount deducted. Your employer will also contribute to your pension providing you meet the qualifying criteria.
In the private sector, your contributions are fixed depending on your salary band. Contributions levels may change from time to time. Your employer doesn’t pay a fixed amount, but is expected to cover the remaining cost of providing you with the agreed level of pension.
In the private sector, you can choose your level of contribution. Your employer will normally match this (up to a point) and it is usually simple to change your contribution level.
Building Up Benefits
In the public sector, you accrue pension benefits every year, expressed as a proportion of salary. The amount you build up each year may be 1/80th, 1/60th, or 1/57th, depending on which scheme you are in. So for example, a teacher in the career average scheme earning £40,000 per year would accumulate £701 in pension benefits for every year of service. Over a 40 year career, this could amount to around £28,000 in pension income. Benefits are guaranteed and index-linked.
You will also have the option of a tax-free pension commencement lump sum. Some schemes offer this in addition to an annual income, while others provide the option to exchange some of your income for a lump sum.
In the private sector, your benefits will depend on your contributions and the investment growth achieved. You have more control and flexibility, but no guarantees. You may even lose money on your investments.
Increasing Your Pension
There are a few options for increasing your benefits in the private sector, although again, these will depend on your specific scheme and when you joined. Broadly, the options are:
Private sector pensions simply offer the option of increasing your contributions. This will increase your retirement pot, although your eventual benefits are not guaranteed.
Transferring Your Benefits
If you change employer within the public sector, you can normally move your benefits to your new employer. If the scheme basis is different, a calculation will take place to convert your existing benefits to the new scheme. The Public Sector Transfer Club streamlines this process.
Some public sector pensions can be transferred to private arrangements, although this usually means that you will lose your guarantees and may end up with a lower pension.
Private pensions can easily be transferred to your new employer’s scheme or to a personal pension. As the benefits are based on your plan value, transferring usually has no impact on your eventual pension. However it’s worth considering charges, as the new plan may be more expensive and there could be set-up costs to consider. You should also check whether your existing scheme has any guarantees or enhanced tax-free cash, as you could lose these by transferring.
Retirement Options
Both types of pension allow you to retire from age 55, although this is increasing to 57.
Public sector pensions have a normal retirement age. For current schemes, this is in line with the State Pension age, although members of older schemes may have a retirement age of 65 or even 60. If you retire before this, your benefits are likely to be reduced to compensate for being paid for longer.
After taking into account any tax-free lump sum, your income will be payable for life, and will normally increase every year. These guarantees are extremely valuable, although relying on a scheme pension alone may limit your flexibility to spend more in the early years of retirement.
Money purchase pensions can be drawn flexibly. You can take a 25% tax-free lump sum, either all at once, or over a number of years. The remaining pot can also be drawn flexibly, although this will be taxed at your normal rate. If you do want to build in some guarantees, you have the option of buying an annuity.
What Happens if You Die?
Both types of pension offer some protection for your loved ones if you die.
Public sector pensions can provide an annual taxable income for your spouse or partner if you die, either while you are still working or in retirement. Most schemes also offer death in service lump sum benefits. Children’s pensions may also be payable.
Private sector pensions can pay out the whole pot to any beneficiary you choose. This is free of tax if you die before age 75. After age 75, the benefits are only taxed when they are withdrawn by the beneficiary.
In conclusion, public sector pensions offer a great deal more security and valuable guarantees. Typically, you will receive a higher pension relative to the amount you have contributed.
On the other hand, private sector pensions can be more flexible and may allow you to pass a higher lump sum on to your loved ones. If you are a member of a public sector scheme, you can increase your flexibility by making AVCs or contributing to a private pension in addition to your main scheme.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.
