Prime Minister Andy Burnham’s announcement that his government plans to make adjustments to the Pensions Triple Lock has spawned many hysterical newspaper headlines, many of them (wrongly) reporting that this spells the end for the mechanism by which the state pension is uplifted every year.
The truth is, as so often, more prosaic; but nevertheless the announcement will mean that, in the long term, the state pension will not experience as generous increases as it would otherwise have done – and this has implications for anyone for whom the state pension forms part of their retirement planning.
The Triple Lock, introduced in 2010 by the coalition government, is designed to protect the value of the state pension from being overtaken by the rising cost of living. It guarantees that the pension will rise each year by the greater of inflation (as measured by the Consumer Prices Index or CPI), average wage growth, or 2.5%.
Over the years that guarantee has become considerably more expensive than first envisaged. The Office for Budgetary Responsibility (OBR) has predicted that the Triple Lock in its current form will cost £15.5 billion by 2030 – three times as expensive as initially forecast. Most commentators have predicted that some modification to the guarantee would be inevitable.
One of the issues is what the Institute for Fiscal Studies calls the ‘ratchet effect: volatile year-on-year spikes in earnings or inflation locking the state pension into ever-increasing levels relative to worker pay.
This is essentially what the government’s announcement is aiming to solve. The new solution has been dubbed the ‘2.5 times lock’ by financial journalist Martin Lewis. Pensions will still rise by the greater of inflation and 2.5%. However, the link to earnings growth will be smoothed out across multiple years – we don’t yet know the exact mechanism for achieving this. The new system also won’t come into effect until 2030.
So headlines predicting that the state pension will fall in real terms are inaccurate. However, the measure will mean that in the long-term, growth of the state pension will not be quite as generous as it would otherwise have been under the existing system.
What does this mean for those planning their retirement? Well, for all but the most well-off, the state pension still plays a more or less important part in retirement financial planning. And if in the future it is not going to rise quite as much as previously thought, that means that the shortfall will need to be made up through private pensions.
Now 118 years old, the state pension remains an important part of retirement planning. It is guaranteed for life; and even with the adjustments announced this week, its spending power will remain protected year-on-year. But the rising cost of providing it, and the continuing squeeze on public finances, means that making financial provision for retirement which goes beyond the state pension is more important than ever.