Lock, Shock and Triple Barrel

The triple lock is about to increase the State Pension by 8.5%, at a time a new report claims the State Pension Age will need to hit 71 by 2050.

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In April 2024 the New State Pension (for those who reach(ed) State Pension Age (SPA) after 5 April 2016) will rise by 8.5% to £221.20 a week. The increase was in line with the triple lock, which fixes the annual increase at the highest of:

• The annual growth in earnings in May-July (8.5% in 2023);

• Annual CPI inflation to September (6.7% for 2023); and

• A 2.5% minimum.

By the time April arrives, 8.5% looks likely to be more than double the rate of price inflation, which had fallen to 3.9% by November.

Source: ONS, DWP, Technical Connection calculations

Will the State Pension survive in its current form?

Recent polling showed that one in three working age people do not believe that the State Pension will exist in 30 years’ time, with those aged 55-64 the most pessimistic. There was even a greater lack of faith that the State Pension would keep pace with inflation over the next decade: only 38% of those surveyed believed it would.

To a degree those pessimistic views are understandable, given the increases to State Pension Age since 2010 and the sidestepping of the triple lock for 2022. However, the Institute for Fiscal Studies (IFS), which commissioned the polling, thinks the gloom is overdone. It points out that the State Pension has risen at least in line with price inflation every year since 1975 and that, in terms of government expenditure, it costs much less than in many other countries. The relatively low cost, partly due to the reforms made since 2010, means that the UK is better placed than many continental countries to continue with something close to its current level of State Pension provision.

One future reform of the UK State Pension, which could well happen, is a redesign of the triple lock. The existing structure has been widely criticised as being too expensive and too unpredictable – since the New State Pension started in 2016, earnings growth has accounted for three increases, as has CPI, while the 2.5% floor was the trigger for two. As the graph illustrates, the net result is a pension which outpaces both earnings and prices, a recipe for long term government funding problems.

And this leads us to the latest study.

A report from the International Longevity Centre (ILC) suggested that SPA rises may need to go up even quicker to deal with the number of people in the UK out of work because of long-term health conditions. 

In the UK, maintaining the current ratio of workers to state pensioners is becoming increasingly challenging. According to the ILC, the state pension age, currently at 66, may need to rise to 70 or 71 to sustain this equilibrium. However, if we consider the working adult population as those aged 20 to 64 to account for education years, the state pension age may need to reach 70+ by as early as 2040.

While the recent stall in life expectancy during austerity and the COVID pandemic temporarily relieved the pressure on raising the state pension age beyond 67 after 2027, the long-term trend points towards an increase to 68 or even 69. The challenge is compounded by workers exiting the workforce prematurely due to health issues, reducing the tax base necessary to fund pensions.

Poor health not only hinders economic output but also raises taxes, presenting a significant barrier to UK economic prosperity. Furthermore, a shrinking working population and a growing economically inactive population create labor shortages that may require migrant labor to compensate.

One potential solution is encouraging people to work longer, but this is not without challenges. Research indicates that only 50% of adults are disability-free and able to work by age 70. To mitigate the need for a drastic increase in the state pension age, increasing the proportion of the economically active population from the current 78% to 85% could be explored, potentially allowing for a more manageable state pension age below 70 from 2040, at least for a few years.

X2Z Comment

The structure of UK pensions is one that has enjoyed a broad political consensus for over a decade.

The State Pension is pitched at a basic subsistence level, providing a foundation on which to build private provision, for many in the form of automatic enrolment in workplace pensions.

For the poorest retirees, the State Pension is a major source of household income, but even for the highest-income fifth of households, the State Pension makes up nearly a quarter of total income, according to the IFS.

Take away that foundation and the pension framework collapses, leaving the government still having to provide a means-tested safety net for the retired poor and creating disincentives to save.