Marc Shoffman
The UK's ageing population continues to put pressure on the state pension and as people live longer, the cost of the controversial triple lock is only set to rise.
The triple lock, which uprates state pension payments each year by the highest of either inflation, wage growth, or 2.5%, is safe for now but as the tax burden continues to grow, there are calls for reform.
The latest proposal has come from Conservative Party leader Kemi Badenoch.
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She has suggested means-testing the state pension to bring down the cost of providing the payments.
Speaking during an LBC phone-in where she was asked if she would keep the triple lock, Badenoch said: "We are going to look at means-testing. Means-testing is something which we don't do properly here."
Estimates from the Office for Budget Responsibility (OBR) suggest the state pension cost around £125 billion last year (2023/4 tax year) so it is no surprise that experts have warned that the triple lock is on borrowed time.
Tom Selby, director of public policy at AJ Bell, says: “Labour committed to maintaining the state pension triple lock for the entirety of this Parliament in their manifesto, meaning they are unlikely to back away from the pledge over the next five years.
“However, at some point the government will need to address the unanswered question of what exactly the policy, which randomly increases the value of the state pension in real terms depending on the economic environment, is attempting to achieve. In short: how much should the state pension be worth and when should people receive it?”
We take a closer look at some alternatives to the state pension triple lock. How can the government safeguard the value of the state pension without placing too much strain on the taxpayer?
Should the state pension be means-tested?
Many pensioners have already lost the winter fuel payment after chancellor Rachel Reeves restricted it to those claiming Pension Credit in one of her first acts in the Treasury.
Badenoch has proposed a more extreme measure, means-testing the state pension.
The Conservatives are no longer in power so there is no suggestion that Labour would even adopt this policy.
But if Reeves did take this on in an effort to balance the books, it could effectively mean high earners miss out on payments they were expecting or thought they were contributing to through national insurance payments throughout their career.
Helen Morrissey, head of retirement analysis, Hargreaves Lansdown, told MoneyWeek: “The state pension forms the bedrock of people’s retirement income and there are very few people who are not reliant on it to some extent.
"Talk of means-testing the state pension causes huge concern and could get in the way of people making decisions such as buying national insurance credits that could improve how much they receive."
Morrissey warns that these kinds of rumours can lead to people being turned off pension saving because they feel they will be penalised for doing the right thing or people leaving themselves short today because they are worried that they may not get a state pension later on.
She adds: "This needs a long term view and so the state pension and the triple lock’s role within it needs to form a key part of the government’s ongoing pension review so people can plan ahead without fear of their hard work being undone further down the line.”
Steven Cameron, director of pensions at Aegon, says such a move would be "highly contentious," adding: "Where do you draw the line, how often would you carry out the means-testing and how would pensioners understand what to expect?"
The provider is instead suggesting a three year ‘smoothing’ rather than means-testing.
Cameron says: “A fairer way might be to adapt the triple lock formula. Rather than increases each year being the highest of earnings growth, inflation or 2.5%, some smoothing could be introduced over time. Pensioners would receive an inflation increase as a minimum, and if over the previous three years wage growth has on average been higher than inflation, they’d get an extra uplift.
“This avoids widely fluctuating outcomes at times when both inflation and earnings growth are unpredictable, smoothing things out but ensuring pensioners still share in sustained increases in the nation's wealth."
However, while the idea of means-testing may be unpopular and unfair in the short-term, Joshua Gerstler, wealth manager at The Orchard Practice, suggests it could be the direction of travel in the future.
"In the long run, the state pension should only go to those that really need it," he says.
"If, when you start your working life, you know that the onus is on you to take responsibility and save/invest for your retirement, then you have 30-40 years to make it happen. Only those that have not been able to do so, rather than those who have not chosen to do so, should receive help from the state."
Alternatives to the state pension triple lock
The Pensions Policy Institute (PPI), an independent research organisation, has published a briefing paper highlighting three alternatives to the state pension triple lock. These included:
- Double lock: This option would see the state pension increase in line with either CPI or earnings growth – whichever measure is highest. This would remove the minimum guaranteed 2.5% increase.
- Earnings-linked option 1: This route would increase the state pension in line with earnings growth.
- Earnings-linked option 2: This option would increase the state pension by an average of CPI and earnings growth.
Each route comes with its own set of pros and cons.
When it comes to route one, the PPI argues that a double lock might be “more palatable for the working population”, as it would reduce the likelihood of the state pension “increasing faster than their own incomes and beyond price rises”.
Meanwhile, route two is unlikely to be popular with pensioners, as it leaves them exposed to risk in periods where the rate of inflation outstrips wage increases. Workers would probably add that they are forced to suffer this risk too, though.
Route three, which takes an average of CPI and earnings growth, offers more of a compromise. This route was originally proposed by the Organisation for Economic Co-operation and Development (OECD), which added that direct help could also be given to pensioners on lower incomes.
The PPI says: “This approach aims to reduce spending on the state pension while directing funds where they are needed the most by reducing the amount paid to the wealthier pensioners and targeting it at those in need.
“However, this approach would have the effect of reducing the state pension as a proportion of average earnings and could play into concerns that younger generations have of the state pension being eroded before they get to receive it.”
It adds that direct help for low-income pensioners could require means-testing, similar to existing Pension Credit measures. However, these measures “tend to have low levels of take-up”, the institute points out, resulting in wasted benefits.
Will the government reform the state pension?
It is important that pensioners are adequately protected against rising costs. Unlike most workers, they don’t have the option of changing their job to chase a higher income. That said, the current system has invited criticism on account of intergenerational unfairness.
The tax burden in the UK is at historic levels, and working households are being asked to fund an increasingly expensive state pension at a time when they are struggling to cope with their own rising bills. On top of this, younger workers are paying for a state pension that they themselves may never receive.
All of this means the triple lock is a political hot potato. Its costliness means it will probably see reforms further down the line, but the government isn’t likely to tinker with it in the short term – not least because it promised to retain the measure as part of its election manifesto.
“Given recent changes to winter fuel payments which spurred immediate calls for a rethink due to the number of people who will struggle to pay their bills this winter as a result, any alterations to the triple lock by Labour seem entirely remote and more so given Rachel Reeves’ recent confirmation that it would stick by the policy,” says Jon Greer, head of retirement policy at Quilter.
How to fund a comfortable retirement
The state pension is only supposed to support a minimum standard of living in retirement, but a whopping 24% of savers say it will be their only source of income once they quit the workplace, according to financial services company SunLife. This means any talk of state pension reform rings alarm bells for pensioners.
The key to funding a decent retirement is to start planning early, so that you can supplement your state pension with a generous private pension. Recent figures from the Pension and Lifetime Savings Association (PLSA) show that a comfortable retirement now costs £43,100 a year for a single-person household, and £59,000 a year for couples.
If you are worried about the cost of your golden years, there are some important steps you can take to boost your retirement savings. These include upping your contributions to your workplace pension scheme; stashing any surplus income in your retirement pot; and taking advantage of any unused pension allowances.
If you don’t currently qualify for the full state pension, you could also consider buying additional National Insurance credits. Likewise, if you take time away from work to help raise children or care for family members, remember that this counts towards your qualifying years. Claiming child benefit will help you rack up those valuable National Insurance credits.
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