Guidance

Security of pension benefits: differences between public service and private schemes

Updated 29 November 2024

Staff transferred from the public service to the private sector as part of a compulsory transfer of employment relating to a contracting out of services will normally retain membership of their public service pension scheme (PSPS). However, in limited circumstances this may not be possible and there may need to be a change in pension arrangements.

The government’s Fair Deal policy describes the pension protections which normally apply to transferring staff in these circumstances.

If staff are not able to remain in their PSPS, the contracting or commissioning authority will usually need to ensure such staff are offered membership of a private sector pension scheme which is certified as broadly comparable to their PSPS immediately before the transfer, Those who join the new employer’s scheme should then be given the option of transferring their benefits accrued within the PSPS into the private sector scheme.

There are many issues which individuals will need to consider before reaching a decision on whether or not to transfer the pension they have built up.

Many of the issues are particular to their circumstances or their assessment of the future and their future career. However, there is one factor that all staff with a transfer option should consider - the level of security of benefits following a transfer.

Information

The Government Actuary’s Department (GAD) has prepared this note to highlight some of the differences between how pension benefits are provided and secured in public service pension schemes compared with the private sector. None of this is advice and members are always encouraged to take their own financial advice on potentially important matters such as this.

GAD is a government body which, among other functions, helps implement various pensions aspects of compulsory staff transfers. GAD has no financial interest in whether employees transfer their accrued public service benefits into private sector schemes. GAD does not give individual financial advice, and this note should not be taken as providing advice. If such advice is required, it should be obtained from an appropriately qualified IFA (Independent Financial Adviser).

Security of benefits in public service pension schemes

Constitution

Public service pension schemes are normally established under an Act of Parliament and are underwritten by the government. The benefits and contributions for each PSPS are normally set out in regulations or rules approved by Parliament. This means that the benefits are guaranteed to be paid under the terms of the legislation.

Apart from the Principal Civil Service Pension Scheme Partnership Scheme, PSPSs generally provide benefits which are defined in the rules or regulations governing the schemes. Pension schemes in both public and private sectors which provide benefits in this form are known as ‘defined benefit schemes.’

Funding

Most PSPSs operate on what is known as a ‘pay-as-you-go’ (or ‘unfunded’) basis. This means that the contributions paid by members and employers are not invested in a fund. They are used, along with money from government, to pay benefits to current pensioners. The Civil Service, NHS, Teachers, Police and Fire schemes all operate on this unfunded basis. The benefits are defined in legislation and are backed by central government.

The Local Government Pension Scheme is the only main public service scheme which invests the contributions paid to pay benefits to current and future pensioners. The benefits are defined in legislation and are backed by the financial strength of local government.

The underlying guarantee applies regardless of the extent to which benefits are funded and so the level of security is very high.

Security of benefits in private sector schemes

Constitution

Private sector pension schemes are usually set up under trust law. This is a structure legally separate from the employer of the scheme members. Each scheme has trustees who are responsible for the running of the scheme in accordance with the terms of the trust and relevant legislation. The scheme’s ‘Trust Deed and Rules’ will include details of the benefits to which scheme members are entitled. Contributions are paid by members and their employer, and these are invested in assets to secure the benefits payable under the scheme. The assets of the scheme are held separately from the employer with the objective that if the employer becomes insolvent the scheme’s assets are still available to meet benefits payable by the scheme.

Private sector schemes are subject to both trust law and pensions law which has developed over the years. Many of the laws governing the way in which schemes operate are intended to provide security to members, although it must be recognised that the level of security offered by these rules is lower than that implied by a government guarantee. Reduced security does increase the risk of a pension scheme member ultimately not receiving the full benefit entitlement prescribed under the scheme rules. An Act of Parliament, the Pensions Act 2004, introduced The Pensions Regulator (the UK regulator for workplace pension Schemes) and other measures with the aim of improving security of private sector pension schemes.

Funding

With the introduction of the Pensions Act 2004, private sector schemes became subject to a ‘Statutory Funding Objective’ (SFO). This means that schemes need to hold sufficient and appropriate assets to cover the value of the scheme’s liabilities. If the value of the scheme’s assets is less than the required amount, then the employer must agree to pay contributions at a rate to address any shortfall over a limited period.

The regulatory funding regime introduced by the Pensions Act 2004 provides a framework for trustees, in agreement with the sponsoring employer, to make funding arrangements to meet the scheme’s pension commitments over the long term, assuming the scheme will continue in existence and be the payer of the ultimate benefit.

The ability of an employer to pay required contributions will depend on the financial strength of the employer. In assessing the funding position of the pension scheme, trustees need to take the financial strength of the employer into account.

While the funding regime is intended to enhance the security of member benefits, it does not guarantee that all member benefits will be paid in full. For example, a company with strong finances and prospects today may be less able to support the pension scheme in the long-term as circumstances change. Further, pension schemes are not typically funded to a level where benefits could be bought out in full with an insurance company. This reflects the price insurance companies charge for securing benefits which tends to be relatively high due to their operating requirements.

Even though the scheme is separate from the company, in most cases it is impractical for the scheme to continue indefinitely without a sponsoring employer and the primary option is to use whatever funds are available to buy benefits for the members from an insurance company.

Benefit protections

The Pensions Act 2004 also introduced a new arrangement called the Pensions Protection Fund (PPF). This Fund is designed to provide some protection for scheme members if an employer insolvency left an underfunded pension scheme. However, it should be noted that the PPF is unlikely to protect the full amount of scheme members’ benefits. For example, the PPF only covers 90% of benefits for members under their normal retirement age.

Members’ benefits may also be subject to a cap. Future increases in pensions provided by the PPF may not be as valuable as the increases provided by the employer’s pension scheme. It should also be noted that the PPF is funded by a levy paid by all schemes eligible for its protection, but it has no underlying government guarantee.

General pensions law

• Amendment of scheme rules

The Pensions Act 1995 introduced a requirement that no pension scheme could reduce the value of a member’s pension entitlement to date without that member’s consent. The detail of this protection was changed slightly by the Pension Act 2004, but the fundamental principle remains that benefits already built up cannot be reduced although the ability of the pension scheme to pay benefits in full relies on the ability of the sponsoring employer to pay the required contributions.

• Debt on employers

The Pensions Act 1995 also introduced an obligation on employers to pay additional money into the scheme in the event the scheme was discontinued. Employers must pay sufficient to fully secure benefits with insurance companies. This applies equally to solvent and insolvent employers, although in cases of insolvency there are unlikely to be sufficient funds available to meet this obligation. If, after any amounts recoverable have been collected, there are insufficient funds to fully secure benefits the PPF remains as a fall back.

Transfers from public to private sector - Fair Deal protection

Under Fair Deal when employees are transferred to private sector schemes those schemes must comply with additional provisions, over and above those imposed by general pensions law. These are intended to give transferring members additional security for their pension benefits although the ability of the pension scheme to pay benefits in full relies on the ability of the sponsoring employer to pay the required contributions. The main additional protections are:

• Additional security for benefits

The private sector scheme must provide for greater than statutory protection of ex-public service employee benefits in the event of scheme wind-up, onward compulsory transfer of employment and scheme amendment.

In each case the statutory requirement is to protect members’ entitlements based on leaving service benefits. This would consider a member’s pensionable service and salary at date of leaving and, normally, allow only for increases in the period between leaving and retirement in line with price inflation subject to a maximum increase each year.

Under the additional provisions for members transferring from the public service the protection must consider a member’s pensionable service and salary at date of leaving but then allow for expected salary increases in the period between leaving and retirement.

• Individual transfer values

For ex-public service employees leaving the private sector scheme voluntarily the scheme must offer a transfer value which represents the full value of the member’s accrued rights. The statutory provision would otherwise allow schemes to reduce transfer values if the scheme was underfunded at the time.

First published: 2006 Updated: Nov. 2024