Scottish Sunday Times: Time to bin pot of gold?

State workers are looking forward to gilt-edged pensions, but Scots taxpayers will be left to carry the can, writes Jason Allardyce.

With Scotland lurching towards a recession and unemployment starting to climb, public sector pensions remain one of the country's few growth industries. In the past five years contributions from employers have risen by nearly a third and the total pension pot is now worth £ 130 billion, proportionately higher than the rest of the UK.

Among the beneficiaries are more than 2,000 "pension millionaires" with packages worth seven figures.

What makes public sector pensions so attractive and lucrative is that 90% of them are final salary schemes, in which the employer guarantees to pay a fixed proportion of the employee's final salary. In most cases it amounts to a 60th of annual salary for every year the employee has worked. While public sector pensions (like their private sector counterparts) are generated through investment funds, stock market performance is irrelevant because the government will make up any shortfall.

In contrast, private pension funds are at the mercy of market fluctuations and have lost up to 30% of their value in the past year. Many pensioners face the prospect of existing on a much reduced income or working well into retirement in the hope that markets recover and the value of their pensions rises accordingly.

In 2004, taxpayers paid £ 461m into Scottish local government pension schemes, as well as £ 404m for NHS staff and £ 252m for teachers. By 2007, that had risen to £ 600m, £ 520m and £ 286m respectively.

The bill is proportionately higher than south of the border because significantly more people are employed in the public sector: one in four compared with fewer than one in five in southeast England.

With only 12% of workers in the private sector on final salary schemes, many people question how long such generosity can be sustained in the public sector.

The final salary scheme for state workers was introduced by Clement Attlee in his postwar government, aimed at protecting the poorest in society. It worked effectively in the 1950s, 60s and 70s, because a large number of taxpayers paid into the scheme and a small number of people enjoyed the benefits. Pensioners enjoyed the benefit for a shorter length of time because life expectancy was lower. But the past two decades have seen huge demographic changes with more people retiring, living longer and consequently drawing higher pensions.

"More and more people are retiring, and those retiring are also living longer," said Tom McPhail, head of pensions research at Hargreaves Lansdown, a financial analyst company. "This means that the original assumption on how the working population supports retired workers is no longer relevant. It's all getting rather crowded. You're getting more and more retired people per taxpayer. The problems began to emerge in the 1980s and by the 1990s it was really becoming apparent that there were heavy strains on the system."

Private sector schemes have already fallen victim to these changes. In the past 15 years, several schemes have gone bust, leaving more than 125,000 contributors out of pocket. Among them were more than 1,000 workers at Allied Steel and Wire, who lost 80% of their pensions when the company went into receivership in 2002.

Thousands of workers also lost their pensions when Dexion, the industrial shelf manufacturer went bust. The government finally introduced a financial assistance scheme to compensate them but many had died before it was implemented.

Private occupational pension schemes lost up to £ 225 billion following the abolition of tax relief on pension funds in the 1990s, leading to a 41% fall in the number of workers with policies. Private schemes are now distrusted, but with the basic state pension down by 20% from its 1950 level, relative to earnings, many private sector workers feel vulnerable as they approach the end of their working lives.

State schemes have not suffered to the same extent. Most still have a pensionable age of 60 with early retirement options. The number of members has risen by one million in the past decade.

According to data compiled by Ros Altmann, a former adviser to Tony Blair, the average public sector worker is entitled to a pension of £ 17,091 a year, from a pension pot of £ 427,227. The average value of a private pension pot is £ 24,160, paying £ 1,086 a year.

The Taxpayers' Alliance calculates that in the UK, there are more than 17,000 retired state employees who receive at least £ 33,000 a year from a pension pot of £ 1m or more. They include former Labour first ministers Henry McLeish and Jack McConnell, who receives a pension of £ 38,454 a year on top of his MSP's salary of £ 55,381.

Corin Taylor, research director at the TaxPayers' Alliance, said the disparity was unacceptable: "The infamous tax raid on pension funds has been a major factor in the collapse of occupational pension provision in the private sector, while gold-plated public sector pensions have remained immune from necessary changes.

"It is not right for taxpayers to be subsidising million pound retirement benefits for the public-sector elite while seeing the value of their own pensions plummet, or in many cases not having a pension at all."

The outlook for taxpayers is bleak. There is an estimated shortfall of £ 43 billion between the assets of Scotland's five main public sector pension schemes - covering council workers, the National Health Service, teachers, police and firefighters -and the amount they are obliged to pay their members.

In Britain, unfunded public sector pension liabilities are estimated to exceed £ 1 trillion, more than 70% of GDP, and 20% of our council tax bills are estimated to cover pensions.

If trends remain unchecked, we all face a choice between higher council tax bills or cuts in services.

"I'm horrified by these figures. They are unsustainable and unfair," said David Watt, executive director of the Institute of Directors.

"Tax levels will have to rise to incredible levels to meet the huge costs associated with paying public sector pensions. The government must address this issue as a matter of urgency."

There are no easy answers. Some analysts say state pensions should be based on a worker's average, rather than final, salary at retirement, or some kind of hybrid arrangement, with final year salary schemes stopped for new entrants.

Others favour a defined contribution -or money purchase -scheme, common in the private sector. This places all the risk with the employee, and contributions are normally too low to provide anything like the pension paid by a final salary scheme.

Under the defined contribution scheme proposed by Hargreaves Lansdown in its September 2008 report, Bridging the Pensions Apartheid, contributions from public sector employers and employees would be paid into a pot for long-term investment.

Payouts would depend on the performance of investments and there would be no guarantee of a certain level of pension. Taxpayers would not have to pay a guaranteed salary if the rate of growth was lower than expected and state workers would get a smaller pension.

For example, a teacher in a final salary scheme would retire on a pension of about £ 28,500 a year. Under the defined contribution scheme, the teacher would get a pension of about £ 19,300 a year. A doctor receiving a pension of £ 45,500 would see the pension cut to £ 31,000, while a police officer on a final salary scheme of £ 25,720 a year would see it fall to £ 18,000.

Such a change would meet resistance from public sector unions -Unison, the largest, has already threatened opposition. Unions and council leaders argue that a decent pension is fair compensation for workers who are rewarded less than if they worked in the private sector.

However, figures published by the Office for National Statistics show that the average state salary in Scotland is £ 21,166 compared with £ 19,611 in the private sector.

Earlier this year, John Swinney, the finance minister, was told by Buck Consultants that gold-plated pensions for public sector workers should be scrapped. The firm said final salary schemes would soon become "untenable" and could risk Scotland's economic growth in the long-term.

It urged him to take the "difficult" political decision of switching the public sector over to defined contribution schemes. But ministers know such a move risks alienating voters and workers.

Instead of advocating the end of final salary schemes in the NHS and education, they have attempted to increase the retirement age to 65 for new entrants. NHS employees must contribute up to 2.5% more of their salary into their pension. But workers are allowed to earn a 60th of final salary for every year of service instead of an 80th. Similar moves for local government take effect next year. But projected savings are meagre -£ 500m in the NHS over the next 50 years and £ 20m a year in Scotland's councils.

Critics say politicians must be brave enough to take tough decisions rather than pander to state employees who are likely to find themselves short on sympathy from the public. Anything else is unlikely to be enough to defuse Scotland's pensions time bomb.

Additional reporting: Kathleen Nutt and Julia Belgutay SO WHO'S NEXT FOR THE CHOP?

SINCE he left school 23 years ago, Harry Bell has worked hard and provided for his family. Then, last Monday, the economic downturn shaking the country struck Venture Plastics, a small manufacturing firm where he worked as an injection moulding technician. He lost his job.

"I've got a wife and two children," said Bell, 39, of Stockton-on-Tees. "It leaves me in a bad position, suddenly going from having wages that cover the bills to nothing."

He signed on at the Jobcentre. Bell, who earned £ 18,000 a year, said: "The jobseeker's allowance is nothing." He is angry, especially with the banks. "The government has bailed them out: what about the rest of us? I've never missed a bill in my life. Yet the banks won't help."

Thousands more workers will find themselves in the same position after Britain last week suffered its worst job losses for more than 15 years. Large corporations are to shed 20,000 workers. Thousands more face the axe at small firms.

The British Chambers of Commerce (BCC) warns that if government measures to counter the recession fail to work, unemployment could rise to 3.25m over 18 months.

John Philpott, of the Chartered Institute for Personnel and Development, said: "We need more co-ordinated international policy action and further interest rate cuts." How Bell lost his job illustrates in microcosm the shockwaves reverberating through the economy. Venture Plastics, which makes mouldings for the car industry, was expanding. Owner Nigel Riley, 40, had boosted turnover by 25% in 12 months.

and had taken on six extra staff. "Until October we had had a reasonable year and had managed to attract new customers," he said Riley."Then the world collapsed," he said.

Carmaker Nissan halted production for two weeks of two models built in Sunderland, with three-day-week production for a further fortnight. It meant a cut in orders to suppliers, including one that outsourced work to Venture Plastics. Riley said: "In the next few months up to 50% of our work may disappear. Car companies are knocking out weeks -BMW (which makes the Mini) have announced they are shutting down for Christmas on December 7 and not opening back up until January 5. We don't have the resources of larger firms to continue paying overheads and bills. We could close."

He, too, is angry at the banks. "They have just announced they are putting our charges up. I feel I am being shafted from all sides."

What are the politicians doing to try to avert this crisis? Attention is focused on the pre-budget report, due a week tomorrow, after Gordon Brown hinted at a package of tax and spending measures directed towards small businesses and families.

The Institute of Directors is calling for a 3p cut in income tax and a 4p cut in corporation tax as part of a £ 20 billion package. But some experts are sceptical such measures can be funded without storing up trouble. David Kern, chief economist at the BCC, said: "If the markets interpret the UK measures as being reckless, the pound may plummet."

Whatever the measures, they will come too late for many. Personal bankruptcies in the three months to September jumped 7% over last year. In Bradford, Paul Elgie and Chris Mapp, founders of estate agency Melvin Elgie, were forced to close while still being chased for debts.

Elgie is furious at the way his bank refused to help. "They just pulled the money on us," he said. "Not only will I be made bankrupt, but some of my taxes are going to pay their bonuses."