The Role of Equity Release in Shaping the Future of UK’s State Pensions

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It’s the case that the number of policies that appear popular before an election but are subsequently put into action by a political party after assuming power is typically quite limited. Unfortunately, it’s a common occurrence that our elected officials tend to conveniently forget these promises once the election results are archived for scrutiny by future historians and statisticians.

Nevertheless, in the lead-up to the 2010 general election, the then Chancellor, George Osborne, publicly affirmed his commitment to implementing the ‘triple lock’ mechanism for state pensions. He described this policy as one that would ensure that pensioners “have the means to enjoy a dignified retirement.”

Mr. Osborne kept his promise. The policy is still active, but its future is uncertain. The triple lock is intended to prevent the state pension from being diminished by gradual increases in living costs. Currently, pensions increase by the highest of the following three measures: average earnings, inflation, or 2.5%.

This setup has been beneficial for pensioners: the UK’s state pension increased by 60% from 2010 to 2023, while prices rose by 42% and earnings by 40%.

For a long time, this policy was agreeable to all involved: it was a relatively low-cost measure and hugely popular among the government’s main voters. From April 2013 to April 2022, state pensions saw an average annual increase of 2.8%, but last year, due to a Covid-related anomaly that caused average earnings to skyrocket, pension payments increased by more than 10%. Since then, numerous organizations have been questioning whether the commitment to the triple lock should continue.

Earlier in October 2023, the Organisation for Economic Co-Operation and Development (OECD), based in Paris, recommended that the government abandon the triple lock and instead increase spending on childcare. The organization believes that such a step would alleviate the strain on public finances and control the continuously growing tax burden.

The OECD stated that in the long run, public finances will face pressure as spending related to aging is increasing and the current pension adjustment will be expensive in the future.

In addition, the Institute for Fiscal Studies (IFS) joined the debate, cautioning that the triple lock could contribute an additional £45 billion annually to the state pension expense by 2050. Pensions Minister Mel Stride has indicated that retirees might not receive the full expected increase of 8.5% in 2024. Former Conservative leader William Hague considers the triple lock to be “unsustainable and unfair”.

According to official data, the UK had 12.5 million pensioners at the end of 2022, a number projected to increase by over 20% to 15.2 million by 2045. This significant growth, along with the associated rise in the cost of providing state pensions to an additional three million people, suggests that it would be wise for current and future pensioners to plan their retirement finances, especially considering the inherent shortcomings of the UK’s pension system.

While those who are about to retire or have recently retired may be excited about ending their full-time careers and embracing the freedom to do almost anything for a prolonged period, it’s important to remember that retirement can be costly, particularly in the early years when we are still relatively fit and healthy.

The retirement generation of today have wide-ranging aspirations and extensive lists of destinations they wish to explore. And why shouldn’t they? Most of us are not only healthier but also considerably wealthier than our parents and grandparents, which means that we tend to spend the first decade of our retirement pursuing experiences and visiting places we’ve always wanted to see.

A relatively small number of seniors have enough financial means to spend large portions of their retirement journeying across the world as part of a dream-fulfilling endeavour. Furthermore, even luxurious travel can become exhausting and exceptionally costly. In fact, even a seemingly robust mix of state pension, savings, and an occupational (or personal) pension might not be adequate to fund our most daring retirement aspirations.

This leads us to the inherent issue mentioned earlier. The state pension fund, which collects national insurance contributions and uses them to provide for retirees (note: NICs are not invested but immediately distributed as state pensions), has been under pressure for several years due to the UK’s aging population. Consequently, if state pensions are to continue being distributed, NICs need to increase by approximately 5% to ensure the fund balances out.

This percentage could significantly increase, especially as: a) the number of tax-paying workers continues to decrease and b) the number of people hoping to receive those taxes in the form of a state pension is projected to grow by 230,000 annually until 2046.

Furthermore, potential alterations to the pension system should not be overlooked.

Consider the state pension age as an example. It’s set to increase to 68 by 2028, and there’s a high likelihood it could exceed 70 by 2040. Meanwhile, the triple lock could be modified or completely eliminated, and there’s a possibility that the state pension could be means-tested to consider cash savings or other income sources.

However, there is a solution that may be suitable for some homeowners who are 55 or older.

Equity release might not appeal to everyone, but an increasing number of individuals, eager to explore if 60 is indeed the new 35, effectively address potential gaps in their pension income by utilizing a variety of equity release products.

In essence, equity release allows homeowners over the age of 55 to unlock a portion of the real estate wealth accumulated in their property over many years, typically in the form of tax-free funds. Moreover, once these funds are accessed, most often through a ‘lifetime mortgage’, there is no obligation to make any monthly payments.

However, with the flexibility of today’s equity release plans, more homeowners without affordability issues are taking the option to make flexible voluntary payments of up to 10% each year to manage the future balance – ultimately increasing the size of the legacy they leave behind for their beneficiaries.

There is now more choice in an industry that has listened to the consumer and adapted lifetime mortgage plans to embrace the lifestyle retirees live today, with voluntary payments being just one of those ‘standards’ created by the Equity Release Council to help protect homeowners and their beneficiaries.

The lifetime mortgage is eventually settled when the property’s owner(s) die or move into permanent residential care and the home is sold with the lifetime mortgage repaid from the sale proceeds.

As mentioned above, equity release is not a general panacea and before deciding to top-up a state or private pension with tax-free cash, it’s important for those considering its appeal to take professional advice. Fortunately, this is readily available.

Older people don’t get many opportunities to plug gaps in their pension, but equity release offers what might be considered an attractive option for people who are committed to enjoying their retirement to do just that without necessarily worrying whether the triple lock will remain in place.

To find out how much can be borrowed with a lifetime mortgage we have provided a handy real-time accurate equity release calculator.

Categorised in: Equity Release
This post was written by Mark Gregory