Will the state pension be adequate?

One of the main purposes of any pension reform is to provide pensions that are adequate and sustainable for our future generations. With the latest changes to the state pension taking effect on January 1, I'm somewhat surprised that we haven't yet seen a report explaining how this latest reform measures up against these two fundamental criteria.

Calculating the sustainability of a pension system is somewhat complicated, involving numerous projections of demographics and the economy, which is beyond the scope of these articles. I will therefore concentrate on adequacy, which should be of more interest since it is about how much we can expect to live on when we retire.

"Adequate" is described in the Oxford English Dictionary as "satisfactory" or "acceptable" and this is all the state pension is intended to provide. Nothing more.

State pensions are not designed to make us rich in our old age. They aim to provide a 'satisfactory' income for the rest of our lives, which makes me wonder why so many people seem content to rely on it as their sole source of income when they stop work.

I don't know anyone who wants to go to work for a 'satisfactory' salary, yet that is what we are faced with in retirement if we only rely on the Government.

So how much will the 'satisfactory' pension be when we retire? In order to calculate the maximum we will be entitled to we must make some assumptions on inflation, cost of living adjustments and increases to national average wage.

The following graph shows the maximum pension we can expect to receive, depending on our date of birth. It projects the pension in absolute terms and, more importantly, in today's value, i.e. after allowing for inflation. We have assumed COLA, inflation and increases to average wage all to be 2.5 per cent.

The graph illustrates the absolute maximum pension you can expect to achieve. You will receive a smaller pension if you have made insufficient National Insurance contributions throughout your working life, or if your salary is below the maximum threshold.

Based on our conservative assumptions, it can be seen that, after allowing for inflation, the real value of state pension will be approximately Lm5,000 per annum.

Is this pension adequate? Only you can decide whether the state pension will be enough for you to do the things you want to do in retirement (extra holidays, new cars, treating the grandchildren). However, you should also consider how long you are likely to need to live on this income.

By 2050 a 60-year-old male will be expected on average to live until he is 84, with many people living into their hundreds. In the future it is quite feasible that people will need to live on their pension income for as long as they have worked.

Adequacy is a subjective matter, but one can argue that while the State should provide for the basics in our retirement, we need to accept the responsibility of providing for anything extra.

If you have a pensions-related question please e-mail us at pensions@middlesea.com

Mr Fairbairn is a pensions consultant with Middlesea Valletta Life Assurance Company Ltd, which is authorised to carry on long-term business under the Insurance Business Act, 1998, and is licensed to provide investment services in terms of the Investment Services Act, 1994, in relation to linked long-term contracts of insurance.