I often think people underestimate the impact of the state pension on their retirement income. Most are pleasantly surprised at the difference it makes, but then most people I deal with have been able to accumulate retirement income with our help from other sources. For them the state pension helps, but is not the only source of income. Needless to say, the majority having to survive on just the state pension no doubt have a very different view. More than 70% of single pensioners receive over half of their income from state pension and benefits and it is estimated that the state pension covers <40% of the average person’s outgoings in retirement*.
Those receiving the maximum new state pension of £164 per week, should reflect on the fact that if they were to obtain an equivalent income from a private pension using a 5% income yield, the fund value would have to be in excess of £170,000. However the state pension increases each year (currently by the hopelessly unaffordable ‘triple lock’) therefore I would suggest a conservative estimate to replicate the increases would be a requirement to have a fund nearer £250,000….just for one person! Need I say more? In case you were wondering, you would need to save in excess of £360 per month (allowing for an investment return net of charges of 4% p.a.) over 30 years to reach a fund of £250,000.
Therefore the State Pension and whatever it provides in the future is important and to be valued. However the reality is, it is not affordable. I’ve mentioned the triple lock (a commitment for state pension to increase by the greater of 2.5%, inflation or average earnings). Everyone knows it is not sustainable, but equally everyone knows the outcry that will occur when it has to be removed. Politics and the media will always get in the way of difficult but sometimes necessary decisions. The current state pension provision costs £100bn to fund. As people live longer, the expectation is that it will cost £325bn by 2040 and £831bn by 2060*.
So what solutions are there? Pretend you are Chancellor of the Exchequer for a moment. Which one of the following do you think would be most palatable to the media and the electorate?
- Extend State Pension age to 70?
- Scrap the triple lock
- Increase the qualifying rules for NI contributions from 35 years to 40?
- Cut the weekly state pension payment
- Put up NI contributions or
- Introduce some form of means testing
Of course the last option makes no sense, because any benefit would be lost by the cost to administer it.
It is estimated that just to make the current state pension sustainable going forward for the foreseeable future would require an increase of 6.8% to Class 1 National Insurance Contributions.
So perhaps another solution therefore is to start making savings in one way or another. Another possible option, particularly as the number of qualifying years of NI contributions extends is to ‘top up your state pension’ if you have any ‘missing years’. This still represents very good value costing about £760 to buy an additional annual income of £244 p.a. So it pays for itself after 3.5 years. Somewhat generous – some might say!
*Figures sourced from Government Actuaries Quinquennial review of the National Insurance Fund 2015.
Author: Phil James, Grosvenor Consultancy Ltd
There are advantages and disadvantages to using all of these strategies and they depend on individual circumstances so don’t take action without seeking competent advice. Tax rules, rates and allowances are all subject to change. The Financial Conduct Authority does not regulate tax advice and some forms of offshore investments. The value of investments and the income from them can fall as well as rise, you may not get back the full amount you invested and past performance is no guide to future performance.
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