Regular visitors to this area of the website will know that I have long believed (and no-one has contradicted my supposition) that the UK’s state pension structure operates along similar lines to a giant, albeit legal, Ponzi scheme.
It ‘works’ not because money collected in the form of National Insurance Contributions (NICs) is invested across a variety of stock and other markets by a crack team of investment managers, ably supported by an ultra-professional group of statisticians and sharp-eyed analysts. Far from it.
Instead, NICs collected from the salaries of people of working age, as well as from the businesses for whom they work, is disbursed to those who, having paid NICs throughout their careers, have now retired.
It doesn’t take a mathematical genius to recognise that the biggest long term flaw in this arrangement is the growing imbalance between: a) the number of people contributing to the ‘NIC pot’, and b) those retirees entitled to draw a state pension from the same ‘pot’ after paying NICs themselves for up to fifty years of their working lives. In 1950, this arrangement, known as the ‘dependency ratio’, meant there were five workers making contributions for every one retiree drawing a pension. By 2022, the figure had fallen to 3.3 and according to the OECD, by 2050, it will have dropped to two workers per retiree.
It follows that the state retirement age will almost certainly increase dramatically over the next two decades; it could easily reach 75 within 30 years.
Yet it would be absurd to conclude that the official pension age will continue soaring because pensioners receive a fortune from the state, so making a universal pension payout difficult to justify over the longer term. Au contraire. In fact, it is only in recent years that the state pension has become more generous than at any point over the last previous half century. From April this year, the new state pension will be the equivalent of 30% of average earnings, the highest level since 1968. Hardly living high off the hog, is it?
Indeed, between 1979 and 2010, pensioners had little choice but to accept lower real incomes. In 1979, the state pension was the equivalent of 26% of average full-time earnings; by 2010, that figure had slumped to 16%.
Riding to pensioners’ rescue was Chancellor George Osborne and his gift (of their own money) to retirees, the Triple Lock.
The triple lock was designed to ensure that the state pension was not eroded by gradual rises in the cost of living. Since 2011, state pensions have risen by whichever of the following three measures is highest: average earnings, inflation or 2.5%.
The arrangement proved a boon for pensioners: the UK’s state pension rose by 60% between 2010-23, whereas prices increased by 42% and earnings by 40%, supporting Mr Osborne’s claim that “pensioners [will] have the income to live with dignity in retirement.”
Yet pensions didn’t rise too dramatically. On average, they increased by 2.8% a year between 2013-2022 but thanks to a pandemic which fuelled global inflation, in 2022 they matched average earnings and soared by more than 10%. This one-off statistical anomaly resulted in a number of bodies and observers questioning whether a commitment to the triple lock should remain.
For example, the Organisation for Economic Co-Operation and Development (OECD) urged the government to scrap the triple lock and spend more on childcare instead.
Meanwhile, the Institute for Fiscal Studies (IFS) waded into the argument, warning that the triple lock could add £45 billion a year to the state pension bill by 2050, while former Conservative leader William Hague said the triple lock was “unsustainable and unfair”.
These views, now frequently discussed in the corridors of Westminster, particularly within the Treasury, refuse to go away. Since the turn of the year, we’ve had the (much admired) former pensions minister, Sir Steve Webb, suggest that the triple lock will not exist within a generation, while this month’s Conservative leader, Kemi Badenoch, recently warned that the state pension will eventually be means tested, a development your columnist has warned about for more than a decade.
A combination of stagnant economic growth and excessive government borrowing ensures that the longer-term outlook is less than promising for people of retirement age.
According to recent official calculations, the UK is home to some 12.5 million pensioners, a figure expected to grow by more than 20%, to 15.2 million, by 2045. Given this eye-catching increase, it would be prudent for existing, and soon-to-be pensioners, to carefully plan their retirement finances.
It almost goes without saying that retirement can be expensive, especially in the early years when we’re still comparatively fit and healthy and enjoying the freedom to do almost anything.
Indeed, during the first decade of retirement we rush to tackle experiences and see those destinations we’ve always wanted to visit. Unfortunately, however, even a seemingly healthy-looking combination of state pension, savings and a company (or private) pension may be insufficient to cover the cost of our most ambitious retirement plans.
Which brings us back to that mathematical conundrum referred to above. According to official jargon, the state pension fund has been “under strain” for several years as a result of the UK’s population getting progressively older. Furthermore, this figure could rise significantly, particularly as: a) the number of working people paying taxes continues to fall and b) people wishing to benefit from those taxes, namely retirees, are currently increasing at a rate of 230,000 a year, a rapid, unstoppable expansion forecast to last until 2046.
It almost goes without saying that we should expect ‘reforms’ to the pension system.
Take the state pension age, for instance. Scheduled to rise to age 68 by 2028, there’s an excellent chance of it being above 70 by 2040. In the meantime, the triple lock could be amended or scrapped altogether and there’s every chance the state pension could be means-tested to take account of cash savings or other forms of income.
Before we sink into slough of gloom and doom, however, there is a potential solution to this pension disarray, best suited to some homeowners aged 55 and above.
Equity release feels ubiquitous, on TV, the internet and in print, but what, precisely, is it?
In short, equity release enables homeowners aged 55 and over to release a proportion of the bricks-and-mortar wealth built up in their property, typically over several decades, in the form of tax-free funds. Additionally, once these funds are withdrawn, usually by means of a financial product known as a ‘lifetime mortgage’, there is no legal compulsion to make any monthly payments. The lifetime mortgage is settled when the property’s owner(s) die or move into permanent residential care and the home is sold.
A growing number of people, understandably keen to discover whether 60 really is the new 35, have realised how they may cover potential shortfalls in their pension income by making use of a wide range of equity release products.
Equity release is not for everyone (very few financial products are), so before deciding to top-up a state or private pension with tax-free cash, it’s important for those considering its appeal to take professional advice. Fortunately, this is readily available.
Older people rarely get many opportunities to plug gaps in their pension, but equity release offers what might be considered an attractive option for people who are committed to enjoying their retirement without worrying whether the triple lock will remain in place.
