The covert cost of public sector pensions
Public sector pensions are big news. Costs have escalated to 2% of GDP, and total liabilities are over £1.1 trillion – the same as the entire education budget for more than twenty years.
Although employees contribute to these pensions, even higher contributions are made by the government. Teachers currently pay in 6.4%, but the government puts in more than double this, at 14.1%; NHS workers pay a maximum of 8.5% and the government 14%. The gap is even more extreme in the civil service, where employees pay up to 5% and the government an astonishing 19%.
These figures are public knowledge. What is less well known is that public sector pensions have a hidden subsidy in the form of National Insurance Contributions (NICs).
When you pay into a personal pension, you get tax relief on your contributions, but you don’t get any NICs relief, see Example 1.
Example 1
Mark receives an annual salary of £20,000 a year. His marginal rate of tax is 20%, and he also pays NICs at 12%. So on £1,000 of earnings, he pays £200 of tax, leaving £800; he also pays a further £120 of NICs, giving him net income of £680.
If he pays £800 into his pension, he receives 20% tax relief on that – so the total contribution to his fund is £1,000. Mark gets his tax back. But he never gets the £120 of NICs back.
If he wanted to put £2,800 into his pension, this would cost him £3,182. The NICs on £3,182 @ 12% are £382, leaving him £2,800 to add to his pension scheme.
But if Mark was employed by the public sector, and his employer made a £2,800 contribution instead, the picture would be different.
Example 2
Mark takes a new job in the civil service, also on £20,000 a year. His employer’s contribution is 14% of his earnings. This is £2,800.
There is no tax on this contribution – and no NICs either. So Mark has benefitted from the same contribution to his pension but has not had to pay £382 of NICs, as he did when he was making his own contributions. This £382 saving is equivalent to almost 2% of his gross salary.
It is true that this NIC saving isn’t unique to the public sector; it applies to all employer contributions. But 35% of private sector employees are in jobs where their employer contributes to their pensions – compared to 85% of public sector employees.
So this NIC relief is overwhelmingly of benefit to those in the public sector. It further widens the gap between the generous pension provision given to government workers, and the pensions savings of most other people.
The Chief Secretary to the Treasury, Danny Alexander, has said that he is committed to achieving “a fairer balance between what employees and the taxpayer contribute towards public sector pensions” – but has he considered the hidden NIC costs?
Anne Redston is a visiting professor at King’s College, London and a barrister at Temple Tax Chamber.
The information contained in this article is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. The author and the publisher disclaim all responsibility for any loss arising from any action taken or not taken by anyone using the information in this document.
