The cost of living here in the UK rose sharply during 2021 and 2022. In October 2022, the inflation rate reached a 41-year high at 11.1% before beginning to ease back slowly. In July 2023, it had fallen to 6.8%. Such high inflation impacts the affordability of goods and services, with people reliant on state pensions being particularly vulnerable.
To prevent state pensioners from falling behind in the cost-of-living stakes, in 2010, the Conservative/Liberal Democrat coalition government introduced the Triple Lock mechanism.
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Key Points
- The UK’s inflation rate soared to 11.1% in October 2022 but eased to 6.8% by July 2023, putting financial strain on state pensioners.
- The Triple Lock mechanism, introduced in 2010, adjusts pensions based on the highest of three factors: 2.5%, average wage growth, or inflation, and led to a 10.1% pension increase for the current tax year.
- The rising number of state pensioners and the cost of the Triple Lock are putting financial pressure on the UK government, with State Pension costs expected to rise to £139.5 billion by 2027/2028.
- Despite its benefits, the long-term sustainability of the Triple Lock is questioned, and it was briefly suspended in 2021 due to a post-pandemic earnings spike.
- Individuals are increasingly turning to alternative retirement savings options like workplace pensions, SIPPs, and ISAs, particularly given the tax implications of pension income.
How the Triple Lock Mechanism Works
It works by measuring which of three factors is the highest – 2.5%, average wage growth from May and July (as compared to the same duration the previous year), and inflation according to the consumer price index in the year to September. The outcome of the calculation indicates the amount that pensions will be adjusted by from the beginning of the new tax year.
With inflation running rampant over recent months, the Triple Lock calculation for the current tax year saw a 10.1% come into force. But what about next tax year? What’s in store for 2023-2024?
Across the year to August 2023, the inflation rate, based on the CPI, was 6.8%. In addition to this, the increase in average wages between April to June 2023 was 8.2%, which includes the one-off bonus payments awarded by the NHS.
According to Hargreave Morrissey’s senior pensions and retirement analyst, Helen Morrissey, if earnings continue to grow at 8.2%, the State Pension increase that would be applied from April 2024 would also be 8.2%, increasing the full new state pension to around £11,470 per annum.
The Government’s Commitment to the Triple Lock
While state pensioners who have been trying to cope with the increased cost of living would no doubt welcome another substantial increase, it does put pressure on the government, which has been battling to control the spiralling costs of the State Pension. Despite this, Prime Minister Richi Sunak is standing by the government’s commitment to the Triple Lock mechanism, even though the State Pension burden on the Treasury is on the increase.
As of February 2023, 12.6 million people , an increase of 140,000 people, became eligible for the State Pension. Although the State Pension age was increased above 65 in December 2018, initially reducing eligibility, since October 2020 State Pension age has remained at 66 years of age, and it is not due to start being raised again until 2026.
As for the New State Pension, which was introduced in April 2016, as of February 2023, another 690,000 people became eligible, increasing the total eligibility to around 3.2 million people.
Future Cost Implications for the Government
According to the Department of Work and Pensions, the cost to deliver State Pensions in the last tax year was around £112.5 billion. However, come 2027/2028, the cost in real terms is expected to rise to £139.5 billion.
How Safe is the Triple Lock Long Term?
In 2021, the government announced it would suspend the triple lock following its concerns that a large rise in post-pandemic earnings would have resulted in pensions being increased by 8%.
Therese Coffey, the then Work and Pensions Secretary, announced that the average earnings components of the triple lock mechanism would be disregarded for the coming 2022/2023 tax year pension calculation on account of the figures being, in her words, “skewed and distorted resulting in a statistical anomaly.”
The increase that was finally awarded for 2022/2023 was 3.1%. With average inflation for the year at 8.76%, it meant that those reliant on the State Pension saw their income decrease by over 5.5% in real terms. Will something similar happen again in the future?
Other Options for Retirement Savings
The Triple Lock mechanism was designed to offer short-term relief, and its long-term viability is constantly being questioned. If it does get suspended again or it is discarded completely, those who depend on their State Pensions could be in trouble. But the State Pension should only be viewed as one component of a retirement savings plan. There are other options.
Workplace pensions and automatic enrolment came into force in 2012, and according to figures from the ONS, by April 2021, the participation rate was 79%. But depending on your financial goals, even the state plus a workplace pension might not provide retirees with the income to which they aspire.
Because of this, many individuals now also invest in SIPPs and ISAs as other pension savings vehicles. With the cost-of-living crisis still stubbornly persistent and inflation still higher than the BoE predicted, these additional savings vehicles can significantly boost the total pension amount an individual will receive upon retirement.
It’s also worth keeping in mind that you can contribute to your partner’s pension.
Taking Advantage of Savings and Pensions Allowances
The annual private pension contribution allowance is 100% of your salary with a cap of £60,000 per annum. Any amount up to this cap is not taxable. If you are a high earner, it will pay you to maximise this allowance.
Once the annual pension allowance has been exhausted, many investors turn to ISAs in order to make use of their ISA tax-free allowance, which for the 2023/2024 tax year is £20,000. Maximising this benefit too can considerably supplement to your State Pension. Combining the State Pension with smart investments can help to ensure a comfortable retirement.
Watch Out for the Taxman
The other important thing to bear in mind is that pension income is taxable. Workplace and private pensions (including SIPPs) are usually invested in bonds, ETFs, mutual funds, and stocks and shares, which, in the long term, can grow substantially in value. The good thing is that these pensions are not subject to capital gains tax. The bad news is that they are eligible for income tax.
Income from ISAs, however, doesn’t fall foul of income tax, no matter how much you withdraw. It’s well worth bearing in mind, but at the same time, don’t forget that investing carries risk, although with stocks and shares ISAs, by investing long-term in a wide choice of assets it can help to minimise risk.