The cost of retirement has soared in recent years. Recent analysis suggests younger savers will need a pension pot of at least £1 million, if they want to enjoy their golden years in comfort. This comes at a time when the state pension is becoming increasingly expensive for the government to maintain.
Nobody wants to talk about it in the lead up to the general election, with both Labour and the Conservatives promising to keep the state pension triple lock. The Conservatives have gone a step further, pledging to increase tax thresholds for pensioners too as part of the triple lock plus policy. However, some difficult decisions lie ahead for the next government.
The inbox of the new pensions minister, whoever that ends up being, is “already overflowing with issues”, says Alice Guy, head of pensions and savings at interactive investor. “Millions are still heading for a poor retirement and the new government needs to do more to boost pension saving,” she adds.
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Against this backdrop, independent bodies such as the Institute for Fiscal Studies (IFS) and the Social Market Foundation (SMF) have published papers outlining the key priorities for the next government. These address everything from managing the social effects of a rising state pension age, to expanding existing auto-enrolment rules on workplace schemes.
We highlight five key decisions that could be in focus.
1. Arriving at a long-term plan for the state pension
Pensioners usually turn out in force at the ballot box – so naturally all major parties are vying for their share of the grey vote. The Conservatives typically do particularly well with retirees. This goes some way to explaining why they have announced their triple lock plus pledge, despite concerns that the state pension is already expensive enough even before this reform.
Under the current triple lock policy, state pension payments are raised each year in line with inflation, earnings growth or 2.5% – whichever measure is highest. As a result, pensioners enjoyed a 8.5% boost from April this year. This took the weekly payment to £221.20 for full recipients of the new state pension (up from £203.85). Meanwhile, full recipients of the old state pension saw their weekly payments increase from £156.20 to £169.50.
This is great for pensioners but expensive for workers paying National Insurance. Estimates from the Office for Budget Responsibility (OBR) suggest the state pension cost around £125 billion last year (2023/4 tax year).
Critics say this creates intergenerational unfairness. Younger workers are paying for a state pension that might not exist by the time they reach retirement. Meanwhile, they have not seen their wages go up by the same proportions, and have been grappling with the higher cost of living too.
The IFS has said that the triple lock “increases the level and cost of the state pension in an uncertain, and ultimately unsustainable, way”. Instead, it argues that the government should decide on the “appropriate level of state pension”, before increasing it each year in line with average earnings growth or the rate of inflation (if higher).
We highlighted some alternatives to the triple lock in a recent MoneyWeek article.
2. Preparing for an older working population
The state pension age is currently 66 for both men and women (it used to be 65). It is set to rise again to 67 between 2026 and 2028, before rising again to 68 between 2044 and 2046. However, some experts think it is unlikely to stop there. A report from the International Longevity Centre earlier this year suggested it could rise to 70 or 71 by 2050.
It makes sense for the state pension age to go up. When the old age pension was first introduced in 1909, women lived for around nine years after retirement while men lived for around eight years, on average. Today, some pensioners can expect to spend around a quarter of their life retired.
That said, the government will only be able to push the retirement age back so far before it starts running into difficulties. Many older employees will end up grappling with health issues which could impact their productivity and ability to work.
“The next government will need to decide whether to provide additional support to those not able to work up to an increased state pension age, and how any such support should be targeted, while considering the effects on work incentives and government spending” the IFS has said.
3. Increasing minimum pension contributions
Under current auto-enrolment rules, all employers are legally obliged to offer a workplace pension scheme. Eligible workers are opted in by default and receive 8% of their salary into their pension each year. Three percent is paid in by the employer while the remaining 5% is contributed by the employee.
The government passed the Pensions Act in 2023, which sought to expand the number of employees covered by auto-enrolment rules. For example, the new act includes under-22s and abolishes the lower earnings limit for qualifying earnings. However, the act has not yet been implemented.
These amendments are a positive step in encouraging workers to save for their retirement. However, those impacted would see their take-home pay decrease as a result of any new or increased pension contributions.
The IFS says: “The next government needs to decide whether to go ahead with legislated increases in minimum pension contributions. If they do, they should carefully consider the timing, as well as potential alterations to the policy to help low earners adjust to lower take-home pay.”
The SMF goes a step further, arguing that members of workplace pension schemes should also be “given the right to choose the scheme into which their contributions are paid”. At the moment, an employer makes this decision on your behalf.
4. Making a decision on pension tax relief
Your pension is one of the most tax-efficient ways to save for the future. To encourage savers to plan for the future, the government offers a range of incentives. The main one is pension tax relief – a measure which effectively refunds you the income tax you originally paid on the money when you first earned it.
For example, if you are a basic-rate taxpayer and you put £80 into your pension, HMRC will gross it back up to £100 to refund you for the 20% tax you paid originally. Similarly, if you pay 40% or 45% tax, then you only have to pay £60 or £55 into your pension pot for the government to top it back up to £100.
All savers get the 20% basic-rate tax back immediately. However, if you are a higher or additional-rate taxpayer, you will need to claim the rest back yourself. You can do this by filling out a self-assessment tax return form.
However, the SMF argues that “tax relief on pensions is inevitably regressive, with nearly 60% going towards higher and additional rate taxpayers.” It argues that this unfairly discriminates against the low paid and women.
Instead, the think tank proposes a bonus framework. It writes: “We should replace all tax relief and NICs rebates with a simple bonus, detached from tax-paying status. Bonuses would be paid on individual and employer (post-tax) contributions, capped at £2,500 per year, say. A bonus rate of 25% would facilitate an incentivised annual savings capacity of up to £10,000, more than adequate for 95% of all adults.”
It is worth mentioning that this approach would be unpopular with high and ultra-high earners, who currently enjoy 40 and 45% tax-relief on their contributions. This could result in them putting less money into their pension pots, which would be bad news for the UK investment landscape. Governments are already trying to drive more pension investment into UK companies, after schemes have been diversifying into different regions in recent years.
5. Ensuring savers draw on their pensions appropriately
The cost of living has soared in recent years, and people are living for longer than ever before. Against this backdrop, some are having to “unretire” or risk running into poverty in old age.
With this in mind, the IFS has called on the next government to develop policies to help people draw on their private pension wealth appropriately. “This could mean requiring pension schemes to provide people with decumulation pathways, including solutions that combine annuities with accessible savings pots,” the IFS writes.
It adds that the government could also “require schemes to provide default options, to ensure that these policies also work better for those who don’t engage actively with their pension.”
On top of this, the government needs to do more to encourage the self-employed to save appropriately for their retirement. Currently, only around 20% participate in a private pension scheme, the IFS reports.
If you work for yourself, you aren’t covered by auto-enrolment rules. As a result, you risk running out of money in retirement if you don’t prepare your finances adequately. Some important steps could include signing up to a private pension scheme or saving regularly into a Self Invested Personal Pension (SIPP).
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