To include the State Pension or to ignore the State Pension, that is the question…when you’re retirement planning.
If you’re a millennial (born between 1981 and 1996) or later, I’ve come to a bold conclusion: it’s best to assume you won’t receive a State Pension, when you’re planning how much to save for retirement. Let me explain why… While it's likely that some form of State Pension will persist, I believe there’s a good chance that it will become much less generous or that the state retirement age will increase even further. It is also possible that it will become means-tested so only the least well-off will receive it. Because the UK population is ageing and, as a result, the cost of the State Pension is increasing, one or all of these possibilities is almost inevitable. With an ageing population, a conundrum arises: an increasing number of people require care in their later years, while the workforce available to support them through tax contributions continues to dwindle. And, as State Pensions rely on current tax collections – that is, taxes collected from today’s workers are used to pay today’s pensioners, fewer workers will shoulder the burden of supporting a larger and growing retired population. So pensions will be less generous unless something changes. How has retirement and the State Pension evolved over time? Retirement is still a rather new concept. In the past the average person worked until they physically couldn't anymore; if they were lucky, their family looked after them in old age otherwise they faced serious financial struggles (this is how it still works for many in developing economies). In the UK, the introduction of the means-tested 'Old Age Pension' in 1909 marked a big turning point, providing a modest income to people aged 70+ with an income below £21 a year. The pension payable to a single person of 25p a month is roughly equivalent to about £157/month today (if we account for inflation and the increase in average earnings over time) – very much in line with the current Basic State Pension of £156.20. But...average life expectancy in the UK was about 50 in 1909 so, most people did not reach the state retirement age. This initial State Pension didn’t require any contributions to be made in order to be entitled to it; a contributory State Pension scheme only came about in 1925 for manual workers and others earning £250 a year or less (equivalent to £12,500 in 2023 prices). It wasn’t until after the Second World War, in 1946, when the ‘Welfare State’ was created, that a contributory State Pension applied for all people. From 1946 until 1980 people with higher average earnings enjoyed a higher State Pension, however, linking State Pensions to earnings was abolished in 1980. Personally, I think the new flat rate for all is much fairer. The State Pension has become less generous over time and may need to become less generous still In terms of what the money you receive can purchase, the State Pension seems to have not changed too much since 1909 - it’s just as generous or not so generous, depending on your view, as it ever was. What has changed since the introduction of the Welfare State is the bar you need to meet in order to get a State Pension. Whereas women used to start receiving their State Pension at 60 and men at 65, now, both men and women get it at 65 for the older generation and that’s rising to 68 for my generation. In addition, while someone used to need just 30 qualifying years of National Insurance contributions or credits to get the full basic State Pension, a total of 35 years is now needed and, to get anything at all, at least 10 years of National Insurance contributions or credits is required. These changes reflect the challenges governments face in balancing the needs of retirees with the available resources. To maintain the purchasing power of pensioners, the Government has maintained a 'triple lock' since 2010; under this mechanism the basic State Pension is increased each year by either average wage increases, average price increases (i.e. inflation) or 2.5%, whichever is higher. Despite all this, to continue to be able to take care of those that need it most, more may need to be done. There is only so much that can be done to raise the qualifying age or the number of years of contributions; at some point, it may become necessary to start cutting out those that don’t really need the State Pension given their other sources of income. And if I’m honest, I wouldn’t be upset if this is where we end up because if the government can balance its books it can stop progressively increasing taxes (including through fiscal drag). What does the State Pension currently cost? Consider this: in the 2023-24 fiscal year, an estimated £124.3 billion (10.5% of public spending) is projected to be spent on State Pensions. This figure, equivalent to approximately £4,400 per household, highlights the scale of financial commitment required, particularly when you realise that UK median household disposable income (that’s income after tax) is only about £32,300. Just to give you an idea of how mind-blowing this statistic is, in my native Malawi, the government's budget for the whole year for absolutely everything is £450 per household (UK: £42,000). And, the average Malawian household is 4.3 people compared to just 2.4 people in the UK. And what’s going on with population projections? Without an increase in immigration, the UK’s natural population is projected to start declining by 2025 … that’s in two years; a lot sooner than was expected based on estimates made in 2018; at that point we didn’t expect the natural population to start declining until 2043. So, what’s the long and short of it? There’s no two ways about it, to sustain the current generosity of State Pension in the context of an ageing population, some difficult decisions will have to be made. Sustaining the system will require adjustments such as raising the retirement age further (it’s difficult to imagine, I know) or reassessing eligibility criteria. In the short-term increased immigration may help to boost tax receipts but it’s unlikely to be a long-term solution. Some thorny questions will need to be addressed on how to balance fairness and affordability when it comes to State Pensions. Having enjoyed a sneak peak into the state of our public finances, it seems sensible that if you’re planning how much to save for retirement, as we did last week, especially if you’d like to retire early, then the best approach is to view the State Pension as a bonus. It will be awesome to get it but if you find that you’re not entitled to it, then by saving as though it won’t be there, the retirement you would like to have won’t be scuppered. References How much would the original old age pension be worth today? Basic state pension rates, Royal London Why should I pay national insurance once I've paid enough for a state pension? Steve Webb (former pensions minister) A brief guide to the public finances, OBR Average household income, UK: financial year ending 2022, ONS UK natural population set to start to decline by 2025, FT Government expenditure on state pension in the United Kingdom from 1948/49+, Statista
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Heather on WealthI enjoy helping people think through their personal finances and blog about that here. Join my personal finance community at The Money Spot™. Categories
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