The Future of UK Pensions – 5 Possible Scenarios

On the face of it, the decision to temporarily suspend the triple lock on State Pensions seems reasonable.

Until recently, pensioners could rely on receiving annual increases to their pension, in line with inflation, earnings, or 2.5%, whichever was higher.

However, following the pandemic, the recovery of wages to normal levels meant that pensions would need to increase by 8% in 2022/2023 to keep up. This was seen as unfair, as pensioners did not see their income drop in the same way as many employees. It was also considered to be a major drain on public resources. Removing the measure could save more than £5 billion per year.

While rising prices are a concern, pensioners would still benefit from inflationary protection.

So what’s the problem?

Baroness Ros Altman, a leading pension expert and campaigner, considers the removal of the triple lock a ‘betrayal’ of pensioners^[1]. Her main points are:

•         Existing legislation already allows the official earnings rate to be adjusted to account for major events such as a pandemic. This means that the earnings link could be set at a more reasonable level without removing the triple lock.

•         The goods and services that are pushing up inflation (e.g. food and energy) are basic and essential. However, there is also a ‘downward bias’, as the prices of luxuries, such as eating out and travel, are reducing. This means that lower earners and those reliant on the State Pension will probably see a higher increase in their costs than the official rate of inflation.

•         Even a temporary removal of the triple lock sets a dangerous precedent and carves out a path for potential future reductions.

Assuming that the suspension (and potentially, the removal) of the triple lock is just the first step, there are a number of other measures that could be taken to reduce the value (and therefore the cost) of State Pensions.

Inflationary Caps or Freezes

A State Pension is not only payable for life, but it is also guaranteed to increase every year. This makes it more valuable than even the most generous of workplace pension schemes.

Most final salary pensions have a cap on annual increases, for example, 5% per year. This may not even apply to the whole pension, as rules changed over time and the actual rate of increase could depend on when you built up your pension.

Annuities don’t even include inflation linking as standard – you need to add this as an option, which increases the cost.

Keeping the triple lock, but introducing a cap on increases, could be a potential way forward.

The government has form for introducing pay freezes for public sector workers, both following the pandemic and the 2009 financial crisis. This would be an unpopular option as it would allow the government free rein over pension increases. Even a short-term freeze could be the difference between just getting by and falling into poverty.

Increases to the State Pension Age

The State Pension age used to be 60 for women and 65 for men. However, many people under 40 today will not receive their State Pension until age 68.

The State Pension was never intended to facilitate an easy retirement. When it was introduced in 1948, the life expectancy was 66 for men and 71 for women. The State Pension was simply meant to provide an income during those few short years between retirement and death.

Today’s pensioners can expect to live for as long as 30 years after retiring, particularly if they have enjoyed good health throughout their lives. The State Pension is therefore expensive to provide, and not in line with its original aims.

It would not be unexpected for the State Pension to increase to 70 or beyond within the lifetime of today’s working population.

A Two Tier System

In general, state benefits are paid to those who need them, funded by the tax system.

State Pensions are different, as everyone who has paid into the system (or received credits), can expect a basic income in retirement.

What if State Pensions were means tested? This means that those on a low income, or who had been unable to work for health or caring reasons, would be able to fund a basic standard of living.

Those who could afford to would be expected to make their own arrangements, either through private or company pensions. Some tweaks would be needed to workplace pensions as the contribution and take-up rates are currently too low to secure a comfortable retirement for the average person.

This scenario is probably unrealistic, as the admin involved in means testing could easily outweigh the savings. This is the argument that has been put forward for not means testing the winter fuel allowance – the State Pension system is considerably more complex.

It also has the potential to be severely unpopular amongst taxpayers.

Higher National Insurance Contributions

If the cost of providing State Pensions is too high, why not increase National Insurance Contributions?

Currently, an employee will pay NI contributions of 12% on their earnings between £9,568 and £50,270 per year. This is already set to increase to 13.25% in April next year as the new Health and Social Care Levy is phased in. Further increases to this earnings band are not likely to be tolerated.

However, there are a few other options:

•         Those earning between £6,240 and £9,568 do not pay NI contributions, but still receive credits towards the State Pension. Contributions could be introduced for lower earners.

•         Earnings over £50,270 per year are subject to NI of 2%. (rising to 3.25% in April 2022) This could be increased, although must be balanced with the higher rates of tax paid on this segment of earnings.

•         Employer rates are currently 13.8%.(rising to 15.05% in April 2022) This could be increased without impacting the take-home pay of the employee. Of course, it is likely to have an impact on businesses and wage growth.

Ultimately, this government wants to be seen as a low-tax administration. Further increases are a possibility, but are unlikely to apply in the short-term.

Phasing Out the State Pension

Many people who are under a certain age are questioning whether they will receive a State Pension at all. It is expensive to provide, and is always a source of controversy when it comes to public spending cuts. If it was decided that the State Pension was to be phased out, this would require a generation’s worth of notice, as people in their 30s and 40s have already built up significant credits towards an expected income.

It would also require significant incentives towards saving for your own retirement. Tax relief and matched contributions are already available, but private pension accrual is still not high enough to replace the State Pension.

We cannot predict what will happen, and any changes are likely to be small and gradual. But ultimately, no one should be relying on the State Pension as their sole source of retirement income, particularly if they still have 20+ years of working life left. If you prioritise your own pension and financial plan, you will be less vulnerable to government policy.

Please do not hesitate to contact a member of the team if you would like to find out more about retirement planning.

A pension is a long term investment. The fund value may fluctuate and go down. Your eventual income may depend on the size of the fund at retirement, future interest rates and tax legislation

The information contained herein is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The information is based on our understanding of lsgislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.