Triple lock alternatives: will the government reform the state pension?

The state pension triple lock is loved by pensioners but expensive for the taxpayer, making it a political hot potato.

The policy increases state pension payments each year in line with inflation, wage growth, or by 2.5% – whichever is highest.

In April this year, the state pension increased by 4.1%. Over the course of the year, recipients of the full new state pension will get a pay rise of £472 as a result.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The policy was introduced by the coalition government in 2010 to protect the real value of pensioners’ incomes being eroded by inflation.

An ageing population and high inflation has made the policy more expensive in recent years, and critics argue it is unsustainable.

Many also feel it is unfair to ask taxpayers to fund the policy at a time when their own finances are being squeezed.

The state pension cost the government more than £124 billion in 2023/24, the most recent year available. This is just under half the amount spent on benefits overall.

The cost is expected to spiral further as the pensioner population grows. The number of people at state pension age is expected to increase by 14% between mid-2022 and mid-2032, according to a report published by the Office for National Statistics (ONS) in January this year.

The government has promised not to change the triple lock this Parliament, but its future looks less certain beyond this point.

Chancellor Rachel Reeves is expected to launch the next phase of the government’s pensions review during her Mansion House speech on 15 July.

As well as the private pension landscape, the review is expected to look at the state pension. At this stage, it is unclear what is in scope.

“For millions of pensioners, the state pension is the bedrock of their retirement income,” said Damon Hopkins, head of DC workplace savings at consultancy Broadstone.

“Any changes to the triple lock, an acceleration of state pension age [increases], or moves towards means-testing would be highly controversial.”

A double-lock pensions system

A report from the Institute for Fiscal Studies (IFS), published on 2 July, recommended scrapping the triple lock in favour of a double-lock system.

The think tank said the state pension should rise in line with average earnings growth each year, apart from in years where inflation is higher.

Rather than implementing the new policy immediately, the IFS recommended that the government choose “a target level” of state pension, set as a fraction of economy-wide average earnings.

The government could use the current triple-lock system to reach that target, before switching to the double lock.

“Triple lock indexation ratchets up the value of the state pension over time, increasing the cost of the system in a way that creates additional uncertainty compared with increasing the state pension in line with earnings growth,” the IFS said.

Historically, the government has raised the state pension age to help manage the rising cost of the state pension, however, the IFS says this is unfair to those with lower life expectancies. Furthermore, many are not healthy enough to work into their late-60s.

Low-income households may also be disproportionately affected. They tend to be more reliant on the state pension than wealthier households with larger private pension savings.

An earnings-linked system

Last year, the Pensions Policy Institute (PPI), an independent research organisation, published a briefing paper highlighting three alternatives to the state pension triple lock.

As well as a double lock – similar to the IFS’s recommendation – the PPI looked at two earnings-linked options.

• 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.

The first earnings-linked option risks leaving pensioners exposed in periods where the rate of inflation outstrips wage increases, but the second 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 said: “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 added 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”, resulting in wasted benefits.

Should the state pension be means tested?

As the cost of the state pension balloons – partly driven by the triple-lock guarantee – some have questioned whether the benefit needs a more radical rethink.

Speaking to LBC in January, Conservative Party leader Kemi Badenoch suggested means-testing the state pension.

“Starting with the triple lock is not how to solve the problem,” she said. “We are going to look at means-testing. Means-testing is something which we don't do properly here.”

The Conservatives are no longer in power so there is no suggestion this policy will be adopted. It would almost certainly prove deeply unpopular.

Commenting at the time, Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “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 warned 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, losing their state entitlement because they have built up sufficient wealth elsewhere.

Others could end up leaving themselves short today – effectively oversaving – because they are worried that they may not get a state pension later on.

Steven Cameron, director of pensions at Aegon, added that such a move would be highly contentious. “Where do you draw the line, how often would you carry out the means-testing and how would pensioners understand what to expect?”

The IFS is also against managing costs in this way. In its recent pensions review, the think tank urged the government to commit to never means testing the state pension.

“This promise would help working-age people in planning their retirement, as they could have trust in the state pension being available,” the think tank said. “It is also worth noting that the state pension makes up a large part of incomes even for people on higher incomes.”

The IFS pointed to research which shows the state pension accounts for 71% of retirement income for low-income pensioners (bottom fifth). Even among the richest fifth, it accounts for 23%.