The ‘£287,560’ cost of matching the State Pension

The State Pension has become an early battleground in the upcoming General Election, with the major parties diverging on their plans for the old age payment.

While both Labour and the Conservatives have pledged to keep the ‘Triple Lock’, the incumbent Conservative government has promised to add another protection to the State Pension by uprating the level at which Income Tax for pensioners becomes payable in line with the Triple Lock.

Dubbed the ‘Triple Lock Plus’, it would effectively guarantee that those living solely on the State Pension will not have to pay tax on the payment in the future.

What would a ‘Triple Lock Plus’ mean?

The Triple Lock is the promise to increase the State Pension by the highest of either inflation, wage rises or 2.5%. The policy has seen the State Pension rise rapidly in recent years - from £185.15 a week in 2022/23 to £221.20 today, a rise of more than 19% in two years. That was thanks first to sky-rocketing inflation, and then surging wages. 

The Triple Lock Plus policy would ensure that the Personal Allowance for Income Tax is also raised according to the Triple Lock, but only for those in receipt of the State Pension. The Personal Allowance currently stands at £12,570 a year, meaning that the whole of the current State Pension - worth £11,502.40 a year - falls within the Personal Allowance and can therefore be received without tax being due.

But the Personal Allowance is due to be frozen under current plans until April 2028. According to The Resolution Foundation, estimated rises in the State Pension would mean that the payment would exceed the Personal Allowance by 2028, meaning some of it is taxed¹. The Triple Lock Plus would unfreeze the Personal Allowance for those receiving the State Pension, enabling the whole payment to fall within the tax-free band.

Putting a value on the State Pension - how much is it worth?

Whichever party wins the election, the State Pension is due to rise by the Triple Lock over the life of the next parliament. That will only add to its importance to the finances of retired people - and it is already very important. That’s because the State Pension is extremely valuable income - and very expensive to replace.

How expensive? According to the latest market prices, the rate paid on an annuity right now to a healthy 65-year-old is around 5.148%³. That’s with income payments escalating by 3% a year. On the basis of that rate, it would require £223,434 of pension savings to replace the current full State Pension (available to those retiring after 5 April 2016) of £220.20 a week. 

The reason it costs so much to replace is that the State Pension is, of course, both guaranteed and protected against inflation - two things that are precious and difficult to replicate any other way.

Drawdown is obviously another way to generate an income from retirement savings. If you assume withdrawing 4% a year from a drawdown pot provides a good chance that the savings pot will last for 30 years, then someone would need £287,560⁴ of pension savings in drawdown to recreate State Pension income - more than an annuity and without the guarantee that income will last until they die, but with the benefit that the money remains theirs.

Why the State Pension is so valuable
 

Source: Sharingpensions.co.uk, as at 30.5.24

How to get there

Saving those sorts of sums can be a challenge - but the job is made easier if a client starts early. For example, someone aged 30 and saving until their projected state pension age of 68 would have to set aside about £225 a month into a pension, assuming 5% investment growth after all fees, in order to achieve a pot worth the £287,560 needed to recreate an income to match the current State Pension. However, the State Pension in the future is very likely to be significantly more than it is today in cash terms, so to truly match it with a pension would require the client to save significantly more. 

Maxing out the State Pension

Given the high cost of getting it any other way, it makes sense for clients to maximise the income they get from the State Pension. Entitlement is, of course, based on National Insurance (NI) contributions. To get the full State Pension, someone needs to have made NI contributions for 35 complete years by the time they retire. If a client is unsure of their NI record, they can check for any gaps by using the government’s online service. If they do have any gaps in their record, it may be appropriate to consider paying voluntary NI contributions to fill them, or else filling them with NI credits that apply in some circumstances.  

Source:
¹ Resolution Foundation, 29.5.24
² (£11,502.40 / 5.148) x 100 = £223,434.34                       
³ Sharing Pensions.co.uk, 22.5.24
⁴ (£11,502.40 / 4) x 100 = £287,560