Millions of public servants face the triple blow of working longer, paying larger pension contributions and having less money to live on when they retire.
A drastic overhaul of the pensions paid to NHS staff, teachers, civil servants, council workers, police and other state sector employees is inevitable after a government-commissioned report warned their schemes were in financial crisis.
Lord Hutton, its author, said it was "unsustainable" for most public sector employees to retire at 60 on final salary pension schemes and backed proposals requiring them to pay more money towards their retirement.
Battle lines were drawn between the Government and unions last night as George Osborne, the Chancellor, praised the conclusions as "impressive" while angry union leaders warned that workers would fiercely resist the changes.
Increasing life expectancy and higher numbers of public sector workers has created a £4bn yearly shortfall between retirement payments and the amount of money in their pension funds. The gap, which has to be plugged by the taxpayer, is forecast to increase to £9bn within five years.
Lord Hutton, a former Labour Cabinet minister, also warned there was a growing disparity between the pension systems for public and private sector employees.
And he condemned the final salary schemes as fundamentally unfair to the vast majority of state sector workers as they disproportionately rewarded relatively small numbers of highly-paid public servants such as judges and doctors.
Lord Hutton will produce his final conclusions next year, but made clear the direction of his thoughts in an interim report published ahead of Mr Osborne's Comprehensive Spending Review in 12 days' time.
Although he did not suggest a figure – explaining that was a matter for ministers – he said he supported higher pension contributions. Some experts have forecast that payments could have to rise by 1.5 to 2 per cent of salary for higher earners.
He added that lower earners, such as members of the Armed Forces who are "fighting and dying for us in Afghanistan", should be shielded from larger contributions.
Lord Hutton, who said there should be no dilution of existing pension rights, also signalled that he believed the days where most public servants could retire at 60 were at an end. He said that some could spend 40 per cent of their adult life in retirement.
"It is unsustainable to remain wedded to this idea that you can still retire at 60. We are all living much longer in retirement. We expect to live to 88 or longer."
The peer backed an end to final salary schemes, under which public sector staff can earn up to two-thirds of their wages when they retire. Such "gold-plated" schemes have already largely vanished in private companies.
Lord Hutton said they were "fundamentally unfair" because of the disproportionate rewards received by the highest paid.
One cheaper alternative would to replace them with schemes based on an employee's average pay during their career.
Mr Osborne said: "The report is very impressive and substantial. I think John Hutton is bringing experience that he has as Labour's former work and pensions secretary to bear and he is addressing this whole issue of fairness.
"He's saying that we want decent, generous pension provision that helps people in retirement, people who have worked for the public services through their lives, but we also need to make sure it's affordable for the taxpayer and that's a fair balance."
But unions last night protested that they already faced a pay freeze and hundreds of thousands of job cuts and would resist this latest "assault" on their conditions. The headache for ministers is that the issue of cuts to pension entitlements could unite all the major unions in the heavily unionised public sector.
Brendan Barber, the TUC general secretary, said: "At a time when inflation is breaking targets and pay is already frozen, asking people to pay immediate increased contributions adds up to a significant pay cut."
Paul Noon, the general secretary of Prospect, said: "Civil servants have been subjected to a recruitment embargo, job cuts and attacks on their terms and conditions. They are in no mood to accept unfair and unwarranted attacks on their pension schemes."
But business leaders welcomed the report as a "long-overdue first step" to delivering sustainable pensions in the public sector.
John Cridland, of the CBI said: "Everybody needs to understand the true scale of pension liabilities being built up. Taxpayers cannot be expected to make up the difference."
Q&A: How many does it affect and why don't the sums add up?
How many people are in public sector pension schemes?
Twelve million – or about one in five of the British population. Just over three million former public servants and their dependants are currently drawing pensions. About five million are currently paying into pension schemes; the rest are deferred members.
What jobs did/do they do?
There are around 300 public service pension schemes, but more than 95 per cent of members belong to one of the six largest schemes, covering local government (4.8 million), NHS (2.9 million), teachers (1.8 million), civil service (1.5 million), armed forces (1 million) and police (300,000).
How does the take-up contrast with private companies?
Dramatically – 85 per cent of public sector staff are in a pension scheme, against only 35 per cent of employees in the private sector in company schemes.
And how do the schemes compare?
Public servants typically receive the most generous final salary pensions – those linked to their pay on the day they retire. Such "gold-plated" schemes have almost vanished from the public sector, where pension pay-outs depend on the performance of the money invested on their behalf in pension funds. Public sector pensions are funded by contributions from current employees, rather than from funds built up by the claimants while they are in work. Public sector employers also contribute more into employees' pension pots than private firms.
How fast is the cost of public sector pensions rising?
Last year pensioners and their dependants received almost £32bn from the schemes – an increase of 32 per cent in 10 years – and equivalent of two-thirds of the cost of the basic state pension.
The problem is that the gap between the money in the pension funds and the money paid out is widening, with taxpayers making up the shortfall.
This year the pensions black hole will be about £4bn. It is forecast to more than double to £9.4bn in five years – a financial burden that Chancellor George Osborne has warned is "unsustainable".
Why is it rising?
The main reason is the rapid increase in life expectancy. Many public pension schemes were designed in the early 1970s, when the life expectancy of a 60-year-old was about 18 more years; this has risen to about 28 years and with continuing medical advance is likely to keep growing.
The growth in the public sector in recent decades also means there are more retired pension claimants to support. Finally, stock market volatility has meant modest growth in public sector pension funds.
How much do retired public servants receive?
Despite their apparently generous pension arrangements, the average retired public sector worker receives only around £7,800 a year, with half of workers receiving less than £5,600 a year. The sums reflect the fact that many are on relatively low wages (or work part-time) when they are in employment. However, more than 2,300 retired NHS staff enjoy pensions of at least £67,000.
Has the Government already made changes to public sector pensions?
Yes. Mr Osborne announced in the emergency Budget that, from next April, pensions will be increased in line with the consumer prices index rate of inflation rather than the retail prices rate of inflation. The National Union of Teachers has said the switch would cost pensioners thousands of pounds over the course of their retirement.
The high earner: Building up pension pot of nearly £2m
Ruth Carnall, Chief executive:
The current system, which pays a percentage of the salary upon retirement every year for the rest of a worker's life, has been criticised as benefiting high-flyers. Hutton called the system, "unfair" as it often sees top earners such as Ms Carnall receiving almost twice as much relative to their contribution as those with more modest incomes.
As chief executive of the London Strategic Health Authority Carnall earns about £255,000, which would reportedly give her a pension of about £1.9m.
A new system, which took into account average earnings over her lifetime, would see her paying more into the scheme, while drawing less.
The middle earner: £13,000 a year isn't exactly gold-plated
Chris Tansley, Social work manager:
Having spent 35 years in the public sector, Mr Tansley, 59, is beginning to think about retirement. "I never took out a private pension scheme because the local government one was so good. To suddenly change it now to one which takes into account lower earnings is a real blow.
"I earn a relatively good wage for a public-sector worker at £39,000. My last pension statement said I could expect £13,000 per year upon retirement. That is not gold-plated.
"The number of people who earn six figures in local government is tiny: this will hit the majority and it will hit them hard."
The low earner: Working longer and paying more
Mary Locke, Hospital ward housekeeper:
To 52-year-old Mary, who earns just over £15,000, debates about the fairness of the schemes take a back seat to having enough cash to pay the bills. "My budget is so tight that any increase in contributions is going to come directly from the money I have available to spend on basics. I will be able to draw around £3,000-4,000 when I do retire and I am not sure where the rest is going to come from. I already have to cut down on luxuries and that is without indulging in smoking and drinking. The people at the top may well draw less than they otherwise would, but they are the ones who need it the least. For me, this means working longer, paying more and drawing less."