The state pension is expected to cost around £97 billion for the current tax year. Compare this to the seemingly astronomical cost of running the NHS at £126 billion and you can see why the government has had to continually raise the state pension age to allow the state pension to remain sustainable.
The state pension is a ‘pay as you go’ scheme. That means that the generation that are working pay national insurance and this pays for the state pension for those currently receiving it.
However, we have a big problem as the workers to pensioners ratio is diminishing. So, what can we do to ensure that the state pension remains sustainable for future generations?
Well the state pension age can continue to increase further (even though we aren’t all living as long as we were projecting a few years ago) or the state pension could be reduced.
One quick hit could be to remove the triple-lock. The triple-lock was introduced to help many pensioners get out of poverty and it has no doubt achieved this, which is a good thing. This rule guarantees that once in payment, a person’s state pension will increase by the greater of inflation, average earnings or 2.5% every year. Recently, with low inflation and low average earnings, the increase has been 2.5%, which alone cost an extra £6bn in 2016. Had the triple lock not been in place, and the state pension increased in line with inflation, the government could have saved £2bn.
Another way that will help keep the state pension financially sustainable is increasing national insurance. As mentioned earlier, a proportion of the national insurance contributions paid by those in work are used to fund the State Pension. Currently, on earnings up to c£46K everyone pays 12% of their wages towards NI. Those earning above this threshold only pay 2% on subsequent earnings. Maybe this will have to change by either raising this ceiling or increasing the 2% rate. Or what about those over state pension age paying national insurance? This would certainly help the intergenerational gap that is currently in place.
However, there is no doubt that with so much uncertainty in relation to the state pension, it is even more important for the younger generation to save into a private pension in order to retire with a decent level of income. That is an article for the next edition of QNews!
Stuart Price, Partner and Actuary at Quantum
stuart.price@quantumadvisory.co.uk