Basic State Pension

The decreasing value of the Basic State Pension

The Basic State Pension increases each year by the rise in price inflation. Salaries increase each year by the rise in salary inflation. It is generally accepted that salaries will rise ahead of prices in the long term. A typical estimate might be that salaries increase by 1.5% to 2.5% per year faster than prices. The fact that salaries increase faster than prices means that the Basic State Pension will become a decreasing proportion of peoples earnings at retirement the further they are from retirement. An example should help illustrate this point. Lets take two men they both earn £25,000 per year and are single. However one is aged 60 (Mr Sixty) and the other 65 (Mr SixtyFive). We also need to assume that prices rise by 2.5% per year and salaries by 4.5% per year. Mr SixtyFive will retire today and begin to receive a basic state pension of £4,027.40 per year. This is roughly 16% of his salary at retirement, i.e. £25,000. Five years later Mr Sixty is earning £25,000 * 1.045 * 1.045 * 1.045 * 1.045 * 1.045 = £31,155 per year. The Basic State Pension is now £4,556.63 (i.e. 4,027.40 * 1.025 * 1.025 * 1.025 * 1.025 * 1.025) per year. This is now only 15% of his salary at retirement. Therefore for people further away from retirement the Basic State Pension will slowly become less and less effective. The table below shows the proportion of an individuals final salary that the Basic State Pension will replace in retirement for an individual currently earning £25,000 per year. This is broadly a current average level of earnings.   Years to retirement Basic State Pension as a percentage of average earnings at retirement 0 16 10 13 20 11 30 9 40 7 As you can see whilst the Basic State Pension currently provides an income in retirement of around 16% of average earnings at retirement for a male currently aged 25 it is expected to provide only 7% of post retirement income. When planning for your retirement this sort of decrease in the value of the Basic State Pension is something which needs consideration. This one feature of the BSP which sparks the debate for the Basic State Pension to be linked to salary increases and not price inflation.