The HUGE Pension Gap - Public Sector vs Private Sector Contributions

A recent retirement report from Scottish Widows has found that 38% of people are not making enough pension contributions and therefore are on track for a retirement below the minimum standard.

What’s startling though is the difference in pension contributions for those working in the public sector vs those in the private sector.

Many people still look at public sector pension schemes as gold plated.

They are defined benefit pensions also known as final salary pensions.

These types of pensions are very different to most workplace defined contribution pensions that are now commonplace in the private sector.

For a start, there is no pot of money for each individual in a public sector pension scheme. Instead, there is a promise to pay you a secure income from a specific retirement age for the rest of your life.

The amount of retirement income paid will depend on your salary towards retirement and how long you are part of the pension scheme.

As a public sector worker you do still have pension contributions deducted from your salary, they just don’t really impact your benefits in retirement.

Whereas for a private sector pension. There is no guarantee of income at retirement. Instead, you are saving into a pension pot. What that pot will be when you decide to retire will depend on how much you put in and how well the investments you choose perform.

If public sector pensions are seen as the gold standard, can we match the contributions to try and replicate the same benefits in retirement using a private sector pension?

Just what level of contributions would be required?

Pension schemes for the NHS, Firefighters, Police etc all have slightly different levels of contributions and these levels are compulsory if you join the scheme.

Public sector pensions have had a complicated history and there are many versions of them depending on when you joined the schemes.

Public sector employee contributions are taken from your gross salary, so you benefit from tax relief.

Some of these contribution numbers of staggering.

Yes, public sector pensions are seen as the gold standard in terms of pension benefits but look how much it costs in contributions to provide those benefits.

A combined employee and employer (effectively taxpayer funded) contribution rate of between 28.9% and 51.2% of salary.

The unfunded public sector pension schemes like those shown above are subject to an actuarial valuation every four years. This process assesses the value of the pension rights being built up and then adjusts the level of contributions required to pay for it.

What’s even more staggering is the level of compulsory public sector pension contributions when compared to compulsory private sector contributions.

Nowadays, if join a job in the private sector and you qualify, you will be auto enrolled into a workplace pension.

Employee contributions benefit from tax relief.

Of course, many companies will pay more than the minimum and allow you to pay in more too but no where near the levels required to match the gold-plated public-sector pensions.

So, if you work in the private sector, you are probably destined never to reach the level of pension contributions as those in the public sector but does that matter?

Remember we are not comparing like for like here. Public sector and private sector pensions are two different schemes, defined benefit vs defined contribution and there are many advantages in having a defined contribution pension.

Firstly, when it comes to contribution levels, we don’t need to necessarily reach the level of those required in the public sector as we have a secret weapon. The global stock markets.

A chance to own thousands of the greatest businesses in the world. All that innovation, solving societies problems and participating in their profits.

Private sector defined contribution pensions are also far more flexible than public sector pensions.

As you keep control of the pension pot with a defined contribution pension you can adjust when you take withdrawals and how much you take. It can adapt as your lifestyle changes.

Public sector pensions cannot be changed once in payment.

With control over the pot, it also means you control the investment strategy rather than having to worry about the whims of government and public sector funding.

Yes, governments do mess around with the pension rules but don’t forget, it’s not all about pensions. Just because a pension is specifically designed for you to save for retirement doesn’t mean you can’t invest in other assets to use in retirement.

For example:

• Building a property portfolio and using the rental yield as income.
• Building up investments inside an ISA which are tax free.
• Using physical gold as a store of wealth.

It’s actually a good thing to diversify across assets as it allows you to protect your wealth should the government come sniffing in one particular area.

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