A major report suggests a new way forward for the state pension system, with a focus on certainty and financial security in retirement.
The Future of the State Pension report has been published as part of the Pensions Review, led by the Institute for Fiscal Studies (IFS) in partnership with the abrdn Financial Fairness Trust.
The report suggests ways the state pension can have a sustainable long-term future.
The IFS said the Government should state what it believes to be an appropriate level relative to average earnings.
It currently stands at 30% of median full-time earnings, which is its highest share since at least 1968, though it remains less generous than state pensions provided in many other advanced economies that have much more limited provision of private pensions.
Having set a target, the IFS said the Government should then legislate a pathway to meet it with a specific timetable. In choosing the new level, the Government has to consider the trade-off between a higher income for pensioners and the cost to the public finances.
The IFS said the current pension has many strengths, including simplicity. But research by the Pensions Review indicates several problems. Firstly, there is no sense of what level the pension will reach or when the triple lock guarantee provides neither future pensioners nor government with any certainty regarding the level of the state pension.
Also, many younger people have little confidence in the continued existence of the pension, while decisions over increasing state pension age are uncertain.
A ‘four-point pension guarantee’
The Pensions Review suggests that a new ‘four-point pension guarantee’ could provide greater certainty and confidence over what people can expect to receive from the pension. These four points are:
- Once the pension has reached its target level, 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.
- Both before and after the target level is reached, the state pension will continue to increase at least in line with inflation every year.
- The pension will not be means-tested.
- The 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 pension age would then be fully guaranteed 10 years before they reach it.
The IFS said these suggestions are carefully designed to build on the strengths of the current state pension system and to address some of the key challenges identified in the Pensions Review report.
Some of the challenges mentioned are an ageing population, the future of the triple lock guarantee, raising the pension age and widespread pessimism about whether the state pension will exist in the future.
Heidi Karjalainen, a research economist at IFS and author of the report, said: “A commitment by the Government to a set level of the new state pension relative to average earnings would ensure that pensioners continue to benefit from higher pensions as living standards rise.
“Under our suggested guarantee, they would also be protected from falls in their purchasing power when inflation is high or earnings growth is very weak. In choosing a target, the Government would have to balance carefully the benefits of a higher state pension income, and the cost to the public finances of providing the pension.”
Becky O’Connor, director of public affairs at PensionBee, said: “The IFS review sets out a credible discussion around viable alternatives to the current triple lock method of increasing the pension that could give greater certainty.
“If implemented, the proposals could offer fair and dependable rises in the pension and remove some of the anxiety around increases to the state pension age. However there may be some difficulty in agreeing what the target proportion of average earnings should be.”
