Why your state pension savings are nothing of the sort

State Pension
State Pension

State pension systems across the globe are buckling under the pressure of an ageing population. In Westminster, ministers are plotting a faster increase in the state pension age to 68. Across the channel, the French are striking in protest against an increase in their state pension age to 64. Meanwhile in South Korea, policymakers have warned that its national pension fund will run out of money in just over three decades.

Alarm bells are already ringing over the sustainability of the British state pension system, as the Government’s controversial “triple lock” policy means that the Treasury will spend an extra £11bn on the payments to retirees next spring.

However, the way that the state pension is funded in Britain is unique –  and often misunderstood.

Workers and employers pay a tax called National Insurance on earnings, and the money collected is nominally used to pay for contributory benefits, as well as the state pension.

However, in truth the “National Insurance fund” is used for many purposes. Some of the payments go straight towards the NHS. While the government can top up the NI fund, it can also use a surplus to fund spending elsewhere by buying gilts – its own debt. This is a Government method of moving around its own money.

Andrew Tully, of the pensions provider Canada Life, said that the Government did not design National Insurance rates with the cost of the state pension, nominally the “fund's” biggest expenditure, in mind.

“The link between National Insurance contributions and state pensions is relatively weak,” he said. “NI rates are set according to the overall fiscal policy of the Government.”

While the separation of the NI fund from the main government account therefore has little meaning, it remains under review by the official actuary department. It has forecast that the “fund” will move into a deficit, spending more on the state pension and other benefits than it collects from National Insurance payments. It expects that there will be a £7.1bn gap in the 2024-45 tax year.

The state pension is its most expensive policy. It is forecast to cost the Government more than £105bn in the 2023-24 tax year.

Mr Tully added that the system could come under further strain as the ratio of retirees to workers changed over time.

“By 2045, the number of people of pensionable age will grow to 15.2 million, an increase of 28pc on the level in 2020. The ‘oldest of the old’ cohort is also increasing, with the number of people aged 85 and over projected to almost double to 3.1 million by 2045.

“At the same time, the working age population will increase by much less – around 4.5pc by the mid-2030s, but then remaining around that level by 2045. This shift in the ratio of workers to retirees will have significant implications around the future funding of the state pension. Without some change to the amount of state pension, or the age from which it is paid, taxes will need to rise over time.”

The Treasury would only be compelled to rearrange money in the NI “fund” if its balance fell below a level outlined by the government actuary. This would come in the shape of a “Treasury Grant”, a payment voted by Parliament. The Chancellor would decide the size of such a payment, as long as it did not exceed 17pc of total benefit payments for the financial year concerned.

This is not without precedent – the last time this happened was in the 2015-16 financial year. While current forecasts suggest that the nominal balance in the NI fund will not fall below the Treasury Grant trigger, the margin is narrowing.