The state pension has been a cornerstone of retirement for over a hundred years. However, last tax year’s cost to taxpayers reached £138 billion, and this figure is expected to increase. This trend paints a worrying picture for future retirees, who no longer enjoy final salary schemes, while auto-enrollment pensions are often seen as inadequate for a comfortable retirement.
Experts, including former pensions minister Steve Webb, emphasize the need for a thorough review of the system. Currently, Webb is a partner at consultancy LCP, which supports the idea of raising the state pension age by one year every decade.
The report advocates for at least five years of coverage for pensioners. The national pension currently starts at age 66, but by 2028, it will gradually rise to 67. According to an investment firm, Britain’s state pension offers some of the lowest income support among G7 nations, giving retirees just 22% of their pre-retirement salary, in stark contrast to 76% in Italy.
While the state pension may seem modest, its cost is becoming increasingly unsustainable. It accounted for about 2% of GDP in the mid-20th century, but now stands at around 5%. Projections indicate this could swell to 7.7% by the early 2070s. So, what can be done about it?
• Only 1 in 5 people know their national pension age
Problem
In April, the new state pension will increase by 4.8%, raising payments from a maximum of £230.25 a week (£11,973 annually) to £241.30 (£12,548 per year). This adjustment is based on a “triple lock” system that ensures increases reflect average wage growth, inflation, or a minimum of 2.5%. This hike will be in line with wage growth, leaving many pensioners just below the annual income tax threshold, leading to higher tax bills for those earning over their pension.
Pensions UK has suggested that a single individual requires £13,400 after tax (state pension included) for just a basic lifestyle in retirement. For a “moderate” lifestyle—think a couple of holidays and some dining out—the annual need rises to £31,700. A “comfortable” retirement looks closer to £43,900.
It’s important to note that these figures assume no mortgage or rent during retirement. Yet, for younger generations, that’s increasingly unlikely as they enter the housing market later in life. The average first-time buyer is now around 32 years old, with many taking out long-term mortgages; the average term for a first mortgage has extended to 30.6 years, up from 28 a decade ago.
Housing costs represented 28% of spending for individuals under 30 last year, according to the Intergenerational Foundation—9 percentage points higher than the average for older age groups.
• Gen Z will need £3m to live a ‘comfortable’ retirement
The demand for a sufficient state pension is likely to heighten, but funding remains a concern. Taxpayer numbers are declining, with women now averaging only 1.44 children, a steep drop from 2.93 in 1964.
While supplementing the state pension with private or workplace pensions appears to be the solution, workplace auto-enrollment initiated in 2012 has changed the retirement landscape significantly, providing more people with some form of private pension.
Marianna Hunt from Fidelity International noted that, in the UK, the state pension serves as a base, unlike in countries like France and Italy, where it’s a primary retirement benefit. However, personal and workplace pensions are increasingly vital for achieving comfortable retirements since state support alone can fall short. Many believe the current minimum contribution rate of 8% through workplace schemes, even combined with the state pension, may not suffice.
• Thank you to the Waspi women. They taught us a lesson about retirement.
Average lifespan problem
When the National Pension was introduced in 1908, it was available only to those aged 70 and over and was means-tested, aimed primarily at providing relief for “people of good character.” By 1925, a contributory system was established, lowering the eligibility age to 65 for men and later 60 for women. The 1995 Pension Law equalized the pension age for men and women, which has since risen to 66. The threshold of 67 will be reached by 2028, followed by a potential rise to 68 between 2044 and 2046.
But life expectancy is climbing even more rapidly. Between 1900 and 2000, life expectancy for those in the workforce jumped by 17 years, and many current retirees may spend over 30% of their lives in retirement.
How to fix
Nearly 20 million people are predicted to retire by 2075, which will impose a significant financial burden, excluding the cost of public sector pensions. Research from the Institute for Fiscal Studies suggests the state pension age may need to climb to 74 by 2068 to sustain the triple lock. A review from a business leader calls for limiting the percentage of an average lifetime that individuals receive their state pension to 31%.
Raising the state pension age seems straightforward enough to curb costs, but it could disproportionately impact communities where life expectancy is lower. For instance, men in Blackpool may only receive state pensions for an average of six years, while women last 11 and a half years. In contrast, in Kensington and Chelsea, it can reach almost 20 years.
The LCP has suggested a minimum payment guarantee akin to private pension structures, ensuring that anyone reaching retirement age receives at least five years’ worth of payments or that their estate does. Webb indicates that this would address fairness concerns that arise when the state pension age is raised, guaranteeing a minimum benefit for contributors.
They believe that this guarantee would only increase costs by roughly 0.5%, since most pensioners tend to live beyond five years. The consultancy also proposed that state pensions be distributed over a fixed average span, such as 20 years, and that the national pension age be incrementally raised by one year every decade to restore balance.
Stuart McDonald from LCP expressed that the current lengthy pension schemes are unsustainable and that a new strategy is necessary. If the system can adjust in line with increases in life expectancy, it could be “fairer for working individuals, as their contributions would directly support retirees.”
Pensions expert and columnist Tom MacPhail has suggested that one way to save the state pension system could be to restrict it to individuals aged over 75.
Triple lock
Tom Selby from AJ Bell believes the first step in fixing the state pension is establishing a new target for the triple lock. He acknowledged that while the triple lock has improved retirement incomes for many, it has also stifled meaningful discussions about the state pension’s value and duration.
He warned that an insistence on maintaining the triple lock could lead to even earlier rises in the state pension age to keep the system viable. This creates uncertainty for younger generations concerning the state pension’s future and, frankly, its viability.
Ultimately, the longer no action is taken, the more detrimental the outcome may be.
