Triple lock: Annual state pension rises are decided by whatever is the highest of price inflation, average earnings growth or 2.5%
The elderly could get a bumper increase in their state pension next year due to temporary wage distortions caused by the Covid-19 crisis.
Average wage growth is already 5.6 per cent due to pandemic effects, which would add a tenner to the full weekly state pension and make it nearly £190 from next April.
That is, if the Government honours the ‘triple lock’, its pledge to increase the state pension by whatever is the highest of price inflation, average earnings growth or 2.5 per cent.
The next state pension rise will not be set for several months yet, but it looks likely to hinge on wage growth this year.
It could head even higher – towards or into double digits – causing a major political dilemma for the Government.
Average earnings might have risen by 5.6 per cent according to the latest data, but the total rise was 8.4 per cent in the year to April 2021.
This suggests the average could head in an upward direction too, and at that level would translate to a £15 a week boost to the state pension, making it nearly £195.
This kind of generosity to pensioners would not only be costly on top of the already gargantuan pandemic bill, but controversial.
Many in the working population are struggling financially due to the pandemic, and the Government has told nurses who battled the virus so valiantly it can only afford to give them a 1 per cent pay hike.
The Government might still avoid this conundrum, as average wage growth could subside rather than accelerate as lower-paid staff rejoin the country’s workforce over the summer.
But the crunch will come when the key wage growth figure that affects the state pension is announced in mid-September, or at the latest when the headline inflation rate – currently 2.1 per cent – is published in October.
If that does point to a lavish hike in the state pension, the Government will have to start managing elderly people’s expectations if it doesn’t intend to honour it, to avoid hopes being raised and dashed unnecessarily.
We explain below how the triple lock works, why it could be broken by wage abberations during the pandemic, and what the Government’s options are to fix it if this leads to a huge state pension increase next spring.
How does the triple lock work?
The triple lock means annual state pension rises are decided by whatever is the highest of price inflation, average earnings growth or 2.5 per cent.
The average earnings lock is based on the three months to July figure, compared with what it was in the same period the year before, and this will be announced in September.
The inflation rate lock is based on September’s figure, which is due out in October.
How is the coronavirus crisis skewing the figures?
The lockdowns imposed to combat the coronavirus pandemic delivered a major shock to the economy.
Now the recovery, however welcome, will cause further ructions. We can therefore expect to see some unusual gyrations in the inflation rate and particularly in average earnings in the months ahead.
Aegon pensions director Steven Cameron explains: ‘Average earnings for the three months to April 2021 increased by 5.6 per cent, but looking at the year to April, total pay grew by a massive 8.4 per cent from 2020 to 2021.
‘This is largely down to the hugely distorting impact the pandemic has had on earnings.
‘April 2020 was the first month where the impact of lockdown and furlough came through into the figures, with many seeing their pay reduce to 80 per cent.
‘The average earnings figures have been further affected over the last 12 months by lockdowns resulting in the loss of many lower paid jobs, meaning the average pay for those remaining in the workforce has increased.
‘This means the increases in national average earnings figures don’t necessarily reflect the reality for many individuals’ pay and we can expect the distortions to continue for some time.’
Sarah Coles, personal finance analyst at Hargreaves Lansdown, says: ‘We’re likely to see some-eye watering average pay rises in the coming months.
‘We’re now comparing wages to the height of the crisis in 2020, when pay fell back for a number of months. As we go through this period, annual wage inflation is going to rise significantly.
‘If the government sticks with its formula for the triple lock, this will automatically feed through into state pension rises.’
What are the options to avoid a sky-high rise in next year’s state pension?
Financial experts have warned for some time that a big correction in pay levels after the Covid-19 crisis could mean a massive increase in the state pension in April 2022.
They have already debated the Government’s main options, including suggestions for temporary reform. These are as follows.
– Keep the triple lock no matter the cost, and ride out the storm
The likelihood of this depends on how big the increase turns out to be. Anything approaching or into double digits, for example, would be provocative to say the least when the Government says it can’t give nurses a rise of more than 1 per cent.
A wild wage inflation figure would push pension rises through the roof
Sarah Coles, Hargreaves Lansdown
Trying to defend a gigantic state pension increase while the nation’s workforce struggles to make ends meet could prove a bigger political nightmare than changing the triple lock.
– Move to a double lock and drop the 2.5 per cent part of the guarantee
This was floated early in the pandemic, and might curb the long-term cost of the triple lock in other circumstances, but it’s not the 2.5 per cent element that is causing a headache at present.
This idea is surely off the table for now given anticipated volatility in wage growth in the near future.
– Suspend the earnings element for a year
A one-off fix like this would allow the Government to maintain its commitment to the triple lock in the longer run.
– Introduce a two or even three-year average for wages
Using more than one years’ worth of figures would smooth out any artificial pay distortions. Or, instead of using an average, the most distorting factors could be omitted from the calculation over a certain period.
This would still give pensioners a rise based on the highest of 2.5 per cent, the inflation rate or wage growth, but the latter would be calculated differently.
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What is most likely to happen?
The chances are the Government will concoct an acceptable fudge if necessary.
Pensioners are very attached to the triple lock, but the majority will realise they can’t expect a preposterously big boost to their state pension based on temporary, pandemic-related spikes in wage growth.
If the Government comes up with a reasonable-sounding solution well before April 2022, but also restates its longer term commitment to the triple lock, that should appease most pensioners and avoid a political row.
Critics have long argued the triple lock is too generous, and an unsustainable burden on today’s workers who fund it via National Insurance contributions.
But any move to axe the pledge entirely would cause a furore among elderly voters, who paid contributions for their state pension throughout their working lives.
Last summer, Prime Minister Boris Johnson was reportedly keen to keep his election promise to maintain it for fear of a backlash.
What do pension experts say?
Current earnings growth will be sending an early warning to the Government that the figure in three months’ time could show a similarly large increase, according to Aegon’s Steven Cameron.
‘If so, the Government will have the difficult decision of whether to stick to the triple lock and grant state pensioners a particularly large increase at a time when many employees may simply be catching up on lost earnings, or break their manifesto commitment,’ he says.
‘This raises real intergenerational fairness issues as it’s those of working age who pay for state pensions through today’s National Insurance contributions.
‘One solution might be to average out the earnings increase figures over a three-year period.’
Sarah Coles, of Hargreaves Lansdown, says: ‘At a time when the government is watching every penny, a double-digit rise in the state pension could call the triple lock itself into question.
‘A wild wage inflation figure would push pension rises through the roof.
‘The government has the option of taking double-digit pension rises on the chin, making temporary changes to the formula to ease the pension rise next year, or tweaking the triple lock itself.
‘The triple lock is the bedrock of people’s retirements, so any questions over its future are bound to raise the alarm. However, it’s also politically difficult for the government to touch it, so it will be wary of making major changes.
‘One option would be to tweak the formula to account for smoothing of earnings. This allows the Government to maintain the triple lock, whilst simultaneously reducing its potency and any unanticipated consequences as a result.’
How much is the state pension?
The basic state pension is currently £137.60. It is topped up by additional state pension entitlements – S2P and Serps – accrued during working years.
The two-tier state system was replaced in 2016 by a new ‘flat rate’ state pension. This is currently worth £179.60 a week.
People who have contracted out of S2P and Serps over the years and retire after April 2016 get less than the full new state pension.
But they can fill gaps in unpaid and or underpaid National Insurance in previous years, and build up more qualifying years if they have enough time between now and state pension age.
Workers needed to have 30 years of qualifying National Insurance contributions to get the old state pension, but they now need to have 35 years of contributions to get the new flat rate state pension.
But even if you paid in full for a whole 35 years, if you contracted out for some years on top of that it might still reduce what you get.
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