The Future Of The State Pension

19th December 2023

The Institute for Fiscal Studies Pensions Review report sets out key challenges for the UK's state pension system and suggests a way forward for the future.

In this major report of the Pensions Review, led by the Institute for Fiscal Studies in partnership with the abrdn Financial Fairness Trust, we consider the role of the state pension in the UK pension system, analyse the key challenges for future generations of pensioners and set out policies that would improve the current system.

The state pension: where are we?
• The state pension can be claimed from age 66 (rising to 67 by 2028). The Department for Work and Pensions (DWP) estimates that by the mid 2030s, 80% of those reaching the state pension age will receive the full ‘new state pension', currently worth £203.85 per week. At 30% of median (full-time) earnings, the full new state pension is at a higher level than the basic state pension was at any point since at least 1968.

• The state pension is an important source of income across the income distribution, although more important for poorer households. For example, among households with someone aged 66-70 where no one is in paid work, the state pension makes up 71% of income for the poorest fifth and 23% for the richest fifth. Indeed, if one wanted to buy an index-linked annuity to provide a pension that was equal to the current value of the new state pension (and then price indexed) from the age of 66, then that would require an outlay of over £200,000. This is a significant sum even at the top of the income distribution.

• Although many older pensioners - and a particularly large proportion of women who reached state pension age before 2010 - are receiving much less than the full new state pension, most new retirees receiving this amount (alongside any means-tested housing benefit and support for council tax) are close to or above the relative poverty line, even if they have no other income.

• Government spending on social security payments to pensioners is expected to be £152 billion (5.9% of national income) in 2023-24. Of this total, spending on the state pension, pension credit and winter fuel payment comprises £132 billion, or 5.1% of national income (the vast majority of the rest of the social security spending is on disability benefits and means-tested housing benefit). The 5.1% compares with 4.4% of national income spent on these payments (state pension, pension credit and predecessors, and winter fuel payment) in 1983-84 and 4.2% of national income in 2003-04.

Challenges facing the state pension
We have identified four key challenges facing the state pension system:

1 The ageing population will add considerable pressure on public finances in coming decades. According to the Office for Budget Responsibility (OBR), under current population projections and government policy (maintaining the triple lock and the state pension age rising to 68 by 2046), spending on the state pension, pension credit and winter fuel payment is expected to rise by 1.2% of national income (£32 billion per year in today's terms) by 2050. One key driver of this is that there are expected to be 25% more pensioners in 2050 than today, with another driver being how the state pension is indexed. The pressures due to health and social care are much bigger, with spending projected to rise by 4.1% of national income (£105 billion per year in today's terms) over the same period.

2 While there is naturally a debate about the right level of the state pension, the ‘triple lock' indexation policy (which increases the state pension each year by the highest of inflation, average earnings growth and 2.5%) ratchets up the value of, and spending on, the state pension over time in a way that creates uncertainty around what the level of the state pension will be relative to average earnings, and for the public finances. Compared with increasing the state pension in line with average earnings, we project that - on its own - the triple lock could easily cost anywhere between an additional £5 billion and £40 billion per year in 2050 in today's terms.

3 If the government wants to rein in state pension spending, then relying only on raising the state pension age to achieve this, rather than moving to less generous indexation, would hit those with lower life expectancy harder. This is because the same increase in the state pension age has a larger proportional impact on the expected state pension wealth of people who die at younger ages than for people who live longer. People who die at younger ages do not benefit as much from the triple lock, which increases the value of the state pension in the future. Groups with lower life expectancy include poorer people (compared with richer people).

4 Despite its new-found simplicity, there is a mixture of confusion and pessimism about the state pension. Although the state pension has increased at least as fast as inflation every year since 1975, 38% of people think that in the next 10 years it will not keep up with inflation. Pessimism is also widespread; a third of people do not think the state pension will exist in 30 years' time.

It is important to note that the new state pension at its current level is just about enough by itself to keep most people out of income poverty (according to standard government metrics). However, there are some people - in particular, single households living in private rented accommodation - for whom the new state pension and means-tested benefits are not enough to keep them above the income poverty line. Take-up of means-tested benefits among retirees is also far from complete; the design of these benefits will be considered in a later report of the Pensions Review.

Even for households for whom the new state pension is enough to keep them above the income poverty line, it is not enough on its own for a comfortable retirement or to provide most people with a standard of living they have been used to in working life. Instead, for most people, the state pension is a basis for building upon with their own savings, rather than the whole of their pension provision.

The future of the state pension: a new way forward
Despite these challenges, our view is that the state pension is not in need of wholesale change. Indeed, its structure has much to commend it. Given where we are, we think we should retain a flat-rate state pension that is neither earnings-related (which would mean higher state pensions for people with higher earnings over their lifetime) nor means-tested (which would mean lower state pensions for pensioners with higher private incomes). Although the state pension is higher than in the past, given its current level we think it should continue to be accessible from a single universal state pension age, rather than being made available from an earlier age at a permanently reduced amount.

However, improvements are needed to address the key challenges set out above, in order to build on the strengths of the current system and provide a sustainable long-term future for the state pension.

We suggest a new ‘four-point pension guarantee' to achieve this:

1 There will be a government target level for the new state pension, expressed as a share of median full-time earnings. Increases in the state pension will in the long run keep pace with growth in average earnings, which ensures that pensioners benefit when living standards rise.

2 Both before and after the target level is reached, the state pension will continue to increase at least in line with inflation every year.

3 The state pension will not be means-tested.

4 The state pension age will only rise as longevity at older ages increases, and never by the full amount of that longevity increase. To increase confidence and understanding, the government will write to people around their 50th birthday stating what their state pension age is expected to be. Their state pension age would then be fully guaranteed 10 years before they reach it.

To set the target level, as the government has done with the minimum wage, politicians should state what they believe to be an appropriate level for the new state pension (and the basic state pension) relative to average earnings (as measured by median full-time earnings). They should then legislate a pathway to meeting that target with a specific timetable. This would result in an explicit commitment from the government to target a level of state pension relative to average earnings, which would then be maintained in the long run too.

In choosing the level of the new state pension, the government has to consider the trade-off between a higher income for pensioners and the public finance implications that will have. As an illustration of the cost of increasing the value of the state pension relative to average earnings, Figure ES.1 shows the cost in 2050 of different levels of the state pension (measured in today's terms) relative to keeping the state pension, as today, at 30% of median full-time earnings (which itself would lead to a saving of £24 billion per year in today's terms compared with the expected cost of the triple lock).

Read the full Executive summary HERE
There is much more on the IFS web site including several graphs.

Read and download the full report HERE
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