Q&A: What is the story with the cost of public sector pensions?

A guide to what you need to know about the rising cost of the State’s pension liability

What do the latest figures on public sector pensions show?

They show a State liability of €149.6 billion. This is an estimate, in today’s money, of the liability the State faces from paying pensions in the years ahead to employees currently on its books. This is equivalent to not far off half of GDP for 2018, the year to which the figures refer. The liability prediction is based on estimates of pay increases, the age at which people retire and, crucially, life expectancy. A formula is used to translate this back to one overall figure.

Why is the liability important?

The liability has increased sharply in recent years – up from an estimate of €114 billion in 2017 – driven up by increasing life expectancy and by assumptions about interest rates and inflation. The money to pay these pensions each year comes out of general Government spending. The bill is already increasing – an analysis undertaken for the Government said the annual gross cost of public sector pensions would rise from €3.4 billion in 2017 to €5.3 billion in 2025. The rise reflects the ageing of the public service – in line with the general population – the fact people are living longer and the pension rules which apply to those taken on before 2013.

What pension terms apply to public servants?

Public sector pensions are paid on a defined benefit basis – in other words, the payments are based on salary and offer a guaranteed amount. A public servant with a full 40 years of service will retire on an annual pension equivalent to half of their salary and a tax-free lump sum of 1½ times their annual pay. Those in jobs with the Garda and prison service accrue entitlements more quickly.

The rules have been tightened over the years. For those who joined the public sector from 1995 on, the occupational pension is integrated with the State pension. Pension contributions were also more widely introduced in 1995. Now, public servants generally pay 6.5 per cent of their salary towards their pension and for coverage of their spouse.

A big change came in 2013 with the introduction of the new so-called single scheme. Public servants recruited from then on retire on a pension based on average salary over their career – rather than final salary, which applies to the pre-2013 group.Their annual pension increases will be based on inflation, rather than tied to the pay increases of those in work, as applied to the pre-2013 public servants. These two changes make a big difference, and will start to reduce the pension bill later this century when large numbers of this younger group start to retire.

So more established public servants get a better deal?

Yes. The actuarial report containing the latest figures estimates that if all public servants were to be paid increases based on inflation rather than on pay parity, the long-term liability would fall to €126.6 billion, a 15 per cent decrease. Under legislation, Minister for Public Expenditure and Reform Michael McGrath can make this change – as the actuarial report points out – but there are no signs that he intends to do so. The report assumes that wage growth in the public sector averages about 3.5 per cent a year, significantly increasing the pensions bill.

How does it work out in practice?

Simple enough. For example, a teacher retiring with a full 40 years of service on a €60,000 salary would currently receive a pension of €30,000 a year – which would then increase in line with pay rises – and a €90,000 tax-free lump sum. Lump sums are tax free up to €200,000, a figure which would affect only the highest public-sector earners. If the teacher has 35 years’ service, he or she would not have accrued a full pension and would retire on a pension of €26,250 and with a lump sum of €78,750. Slightly different rules and retirement ages apply across the public service and depending on when people joined the public service.

How does this relate to private sector pensions?

Private sector occupational pension coverage has become a major issue in recent years. Employers have closed defined benefit schemes – due to the expense of paying for them. Most private sector employees are now in defined contribution schemes, where the pension depends on how much you pay in and how your fund performs, and so there is no certainty on retirement income.

As interest rates have plunged, it now costs a private sector employee in a defined contribution scheme a lot more to “buy” the kind of pension entitlement available in the public sector. Isme, the SME lobby group, has taken a legal action arguing that the rules on pensions are now unfair, as the taxation of private sector pots in excess of €2 million puts private sector employees at a disadvantage.

There is also a large group in the private sector without occupational pensions who will depend solely on the State pension on retirement – there have been plans to address this via some type of automatic enrolment but this hasn’t happened yet.