State pension gap: £2,600 shortfall to secure “basic retirement”

The state pension will rise by 8.5% in April, giving millions of pensioners a welcome boost to their retirement income.

Under the triple-lock guarantee, the state pension goes up in line with wage growth (as measured in the three months to July), inflation (September's CPI reading), or 2.5% – whichever is higher. 

Wage growth was highest, at 8.5%, and chancellor Jeremy Hunt confirmed in the Autumn Statement that the state payout would therefore increase by this amount in April. 

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An 8.5% jump means the full new state pension will rise to £221.20 per week from £203.85, while the full basic state pension will rise to £169.50 a week from £156.20. 

This adds up to £11,502 a year for those receiving the full new state pension, compared to the current £10,600.

However, despite this significant rise, analysis by the platform Interactive Investor reveals that the state pension is still not enough to achieve a “basic retirement income”.

We look at what the shortfall is - and tips on how to bridge the gap - as well as another sting in the tail with a rapidly rising state pension: tax. 

What does “basic retirement income” mean?

Interactive Investor’s calculation of how much a retiree needs for a basic income is based on the Pensions and Lifetime Savings Association’s retirement living standards. At the start of this year, the PLSA said a minimum annual income for a retiree was £12,800. Interactive Investor has uprated this amount with September’s inflation figure, to give a value of £14,143.

According to the PLSA, this minimum - or basic - income will cover all your needs in retirement, with some left over for fun and social occasions. You could holiday in the UK, eat out about once a month and do some affordable leisure activities about twice a week.

The PLSA also has higher income levels - called “moderate” and “comfortable” - which allow for more luxuries in retirement, like foreign holidays and theatre trips.

What is the shortfall?

Compared to the current state pension - which is £10,600 a year, for someone receiving the full new state pension - there is obviously a big gap between the amount needed to produce a basic retirement income. The shortfall is £3,543.

As mentioned, the state pension will rise by 8.5% next April, giving an annual figure of £11,502 for pensioners receiving the full payout. But this is still not enough to secure a basic income of £14,143. It is still £2,641 short.

“The state pension rise is great news for millions of pensioners and will make it easier for them to pay the bills in a time of soaring inflation. But for the millions of pensioners who rely on the state pension alone, the rise won’t be enough to provide even a basic standard of living in retirement,” says Alice Guy, head of pensions and savings at Interactive Investor.

She adds that many older pensioners receive much less than the headline state pension figures as the higher “new state pension” was only introduced seven years ago. “Older pensioners who retired before April 2016 are only due to receive £8,816 next April – their income will fall an enormous £5,330 short of the amount needed for a basic income in retirement.”

How to boost your retirement income

Increasing your contributions into a workplace or personal pension is a great way to boost your retirement pot: you’ll likely get more tax relief from the government, plus your employer may pay some more money in too.

An easy and painless way to increase your pension contribution - without affecting your take-home pay - is to do it whenever you get a pay rise.

You can also roll over unused allowances. The pension annual allowance is currently £60,000 for most people. So if you didn’t use up your allowance over the past few years, this could be a way to pay a large lump sum into your pension, perhaps from a bonus or inheritance, and still qualify for tax relief.

We have lots more tips here: How to boost your pension pot by over £100,000.

If you’re self-employed, it’s vital you also put money away for retirement - even though you won’t benefit from an employer contributing into a pension on your behalf. You will still get tax relief though, and the power of compound interest, which means pension contributions today can add up to a tidy sum by the time you retire.

More than three-quarters (76%) of the self-employed are not paying into a pension, according to a survey by Interactive Investor.

More pensioners caught in the tax net

An inflation-busting state pension increase causes potential tax implications.

The personal allowance, which is the amount of income you can receive before paying tax, has been frozen at £12,570 since 2021/2022 and will remain so for the next few years.

Dean Butler, managing director for retail direct at Standard Life, points out that back in 2019/20, the full state pension payment filled 70% of the personal allowance. But next April, the rising state pension will take up 92% of the frozen allowance, “leaving pensioners with only £1,070 of headroom before they begin paying income tax”.

This means retirees with just a small amount of extra income, say from an annuity, pension drawdown payments, a part-time job, or a buy-to-let, could easily bust the personal allowance and have to pay basic-rate tax.

Those with a decent level of other income could find themselves pushed into the higher-rate tax bracket and have to pay 40% tax on more of their money.