Pensions are an important element of the employment contract between the 240 colleges in England and their 150,000 people (111,000 full-time equivalent staff).
Colleges participate in two very large public sector schemes: the Teachers' Pension Scheme (TPS) and the Local Government Pension Scheme (LGPS). Their participation is governed by law and there are both recent and forthcoming changes to both schemes.
- Colleges, TPS and LGPS
- the LGPS scheme following the 2014 reforms
- the TPS scheme following the 2015 reforms
- forthcoming changes following the McCloud judgement
- TPS employer contributions since 2019 following the valuation as at 31 March 2016
- LGPS employer contributions since 2020 following the valuations as at 31 March 2019
- pension tax rules
Colleges, TPS and LGPS
Staff who are employed by colleges are entitled in law to join either the Teacher Pension Scheme (if they have a teaching role) of the Local Government Pension Scheme (in any other role). Membership is not compulsory - individuals can opt out of membership - but auto enrolment rules require all employers above a certain size (including all colleges) to enrol staff in pension schemes unless they opt-out. This chart summarises the key points about membership.
The LGPS scheme following the 2014 reforms
The LGPS scheme was reformed between 2011 and 2014. Information on the current scheme is available here or on the websites of the individual funds.
The TPS scheme following the 2015 reforms
The TPS scheme was reformed between 2011 and 2015. Information on the current scheme is available here.
Changes following the McCloud judgement
The McCloud judgement brings significant changes to public sector pension schemes in 2022. Back in 2018, the Court of Appeal ruled that that transitional protection given to pension scheme members who were ten years or less from retirement represented age discrimination because it gave advantages to older members over younger members. The judgement related to the judges (McCloud) and firefighters (Sargeant) schemes but the government decided it would not win an appeal and, instead, is reforming all public sector schemes (including TPS and LGPS) to extend the transitional protection arrangements to all pension scheme members for a 7 year period. There are several aspects to the reforms but the key points are:
- TPS members who were in the scheme in 2012 will have the option to have pension service between 2015 and 2022 calculated on a final salary basis. Some members will have benefitted more from the career average calculations used since 2015 so the rules give pension members the choice between two methods which they can exercise when they take their pension. This has been described as the Deferred Choice option.
- the new arrangements come into effect from 1 April 2022 but DfE is still working through the details via changes to the TPS regulations so some of the impact will be retrospective.
- transitional protection works differently in LGPS so the McCloud-related adjustments affect a smaller number of members and will take effect in April 2023.
These changes make the rules more complicated and create a need both for more information for members and changes to administration. Actuaries have estimated a large costs associated with the McCloud changes (£2.5 billion a year in additional pension costs between 2015 and 2022 across the public sector schemes, adding 6% to total payments each year (and probably more to liabilities) but the next update on costs will come in the forthcoming valuations which take place across LGPS in the second half of 2022 (valuation as at 31 March 2022, leading to changes with effect from 1 April 2023) and in TPS in 2023 (valuation as at 31 March 2020, leading to changes in 2024).
TPS employer contributions since 2019 following the valuation as at 31 March 2016
The employer contribution that colleges, schools and post-1992 universities pay to the Teacher Pension Scheme rose from 16.48% to 23.68% in September 2019 - an increase of more than 40%.
Key points about this increase:
- A 23.68% employer contribution from September 2019: All TPS employers will pay the higher 23.68% contribution from September 2019. The contribution includes a 0.08% levy to pay for administration. The underlying rate rises by 43% from 16.4% to 23.6%. There was no change in the income-related contributions that teacher pay, which average 9.6% of salary and which range from 7.4% to 11.7%.
- Increases across all public sector schemes: There were increases across all public sector schemes from April 2019. The NHS employer contribution is rising from 14.3% to 20.6%. The Civil service contribution is rising by about 6% to between 26% and 30%, Police, firefighter and other contributions also rise. The teacher increase was deferred to September 2019 to make budgeting easier.
- New actuarial valuations prompted the employer contribution increases: The increases follow valuations carried out by the government actuary. The valuations are covered by law (the 2013 Public Sector Pensions Act) and are based on Treasury directions. A key change in this round of valuations is a reduction in the discount rate (known as the SCAPE rate) from CPI+3% used in the last valuation to CPI+2.4% from 2019 onwards (see Treasury written statement from 6 September 2018).The previous plan (announced in the Spring 2016 budget) was to use a discount rate of CPI+2.8% in this valuation.
- £5.7 billion in extra employer contributions: These increases amount to an estimated £5.7 billion in extra costs for employers (see Pages 227 and 231 of the Office of Budget Responsibility October 2018 economic and fiscal outlook. The Treasury runs these schemes on a pay-as-you-go so the extra contributions are recorded as income in the national accounts and result in a reduction in net public sector pension spending from £12.6 billion in 2018-9 to £6.7 billion in 2019-20. The breakdown of public service pension scheme expenditure and receipts is in Table 4.8 of the Office of Budget Responsibility's March 2019 supplementary fiscal tables.
- £4.7 billion in funding to cover costs up until 31 March 2021 year only: HM Treasury allocated £4.7 billion in the 2019-20 budget to cover costs in schools, colleges, the NHS and elsewhere. The longer-term deals for the NHS and schools have included funding for pensions but, for the civil service, police and colleges, there is no certainty about funding after 31 March 2021.
- Funding for schools and colleges to cover the increase: DfE distributed a Teacher Pension Scheme Employer Contribution Grant (TPSECG) to schools and colleges for the 2019-20 academic year to fully fund them for the extra costs and has now consolidated the school funding within the core rate. The money is worth about £1 billion a year for schools and £120 million for colleges.
- Questions about the sustainability of TPS: The increase in employer costs mean the education system will start the 2020s with a Teacher Pension Scheme which is more expensive than arrangements in the private sector but not compared to central government . The public sector pension reforms implemented in 2007 and 2015 reduced long-term costs in some ways by increasing the pension age (deferring retirement) and changing the basis on which pensions are indexed (from RPI to CPI) but long-run costs have increased. Low economic growth appears to have resulted in permanently lower interest rates. The switch to career average calculations of pensions seems to have made on a cost neutral basis. There is no reason why the education system cannot manage with a higher 23.68% employer contribution rate but only if public spending on education continues to a high enough level. If not, there is a risk that higher pension costs will reduce the money for other things (eg pay levels, the number of people employed)
- The next valuation and the 2024 contribution changes: The next round of public service pension valuations will assess schemes as at March 2020 and will determine contribution rates and benefits from April 2024 onwards, which is 12 months later than originally planned In correspondence with HM Treasury in 2019, the government actuary hinted that contributions might rise again in this valuation - because the CPI+2.4% discount rate is both above the private sector discount rate and current official economic growth forecasts and because the cost cap mechanism might be breached again. HM Treasury consulted on changes to the discount rate and cost cap mechanism in 2021 which might moderate these effects but has not yet published the consultation outcome The reduction in the discount rate from CPI+3% to CPI+2.4% in the most recent valuation caused a 3.7 percentage point rise in the employer rate.
LGPS employer contributions since 2020 following the valuations as at 31 March 2019
The Local Government Pension Scheme is revalued on a three year cycle. Each fund commissions an actuary to assess its assets and liabilities and to recommend employer contributions in line with the fund's strategy statement. The most recent valuation took place as at 31 March 2019 with contribution changes taking effect for a 3-year period from April 2020 onwards. This was just before the 2020 pandemic hit and the national results of the valuation were:
- total fund assets were £291 billion compared to total fund liabilities of £297 billion
- the total fund deficit was £6 billion in 2019 compared to £37 billion in the 2016 valuation
- the average LGPS funding level rose from below 90% to 98%
Some colleges nevertheless experienced a rise in employer contributions in 2020 for one or more of the following reasons:
- the circumstances of their fund were less positive than the national average
- contributions rose to cover increased estimates of future service
- their fund decided to reduce the deficit recovery period
Interest rates, stock market prices and property prices have all fallen and fluctuated in 2020 in a way that has changed the circumstances of individual funds. The next valuation will take place as at 31 March 2022 and will lead to employer contribution changes from April 2023 (ie start of summer term in the 2022-3 academic year).
Pension tax rules
In the last ten years, government has restricted the pension tax relief by introducing an annual allowance (AA) and lifetime allowance (LTA). This mainly affects people on higher incomes, rising pay and longer service by requiring them to pay tax if their annual or lifetime pension entitlement exceed these thresholds. Changes introduced in 2015-6 have brought more people within scope of these rules. For defined benefit schemes like TPS and LGPS, the pension administrator notifies individuals each autumn of the value of their entitlement and their pension input amount (PIA). If the total entitlement exceeds the lifetime allowance or the PIA exceeds the annual allowance, then it is the individual’s responsibility to settle any tax due via their income tax self-assessment. There is a “scheme pays” option in both TPS and LGPS which defers the tax payment until the pension is drawn.
Individuals should take financial advice before making major decisions affecting their own finances. This paper from Royal London (written for financial advisors) explains options for individuals in helpful detail.
Some principals and chief executives of colleges have either decided voluntarily to withdraw from membership of the relevant scheme or have agreed different employment arrangements with their governing bodies which change their pay arrangements, perhaps by reducing their hours. The cost of the additional taxation has prompted some individuals to retire earlier than they might otherwise have done. A governing body may decide that it wishes to take action to retain and motivate individuals.
Governing bodies need to follow proper processes in deciding senior pay and operate in an environment requiring more transparency. It is reasonable to consider an alternative pay and pension arrangements to ensure they retain a senior postholder. Any decision should be taken – and recorded – in a way that addresses ESFA and OfS requirements.