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You will often hear people grumble how the state pension isn’t enough for a decent standard of living and some go beyond that, saying that it lags it’s international peers. In this article we are going to put that to the test and compare the UK state pension to the rest of world.
What is the UK State Pension?
Before we do we let’s clarify what the UK state pension actually is. The state pension is payable from age 66, to qualify for the full state pension you need 35 qualifying years of making the necessary National Insurance contributions, the full state pension is set to rise to £241.30 per week or call it £12,547 per year and it increases by something called the triple lock, which is the higher of price inflation, increases in wages across the UK or just a flat rate of 2.50%.
The state pension has seen successive governments tinker with the state pension from increasing the state pension age to equalising the state pension age for both men and women which was phased in from 2010. You will often see click bait titles from the media around how the state pension could even be means tested or the triple lock removed.
We know one of the causes of the cost of the state pension increasing is that simply people are living longer. Back when the state pension was introduced in 1946, a 65 year old could expect to live a further 13 years to age 78, whereas today the average life expectancy for a 65 year old male is 85, with a 1 in 4 chance of living to age 92. A catch 22 is that along with an ageing population, birth rates are falling, with the number of workers per retiree falling.
How much would the state pension cost privately?
The state pension is unfunded, which essentially means there isn’t a fund paying for it and instead it is paid for from tax revenues. The UK spends £125 billion on the state pension which is around 5% of GDP.
To put this into context, the department of health and social care budget is is thought to be around £220 billion or 11% of GDP, much of which is attrbitued to the NHS, defence spending is roughly £60 billion or just under the NATO target of 2.5% of GDP. With both an ageing and sicker population, rising geopolitical tensions from the middle east, Russia and the rise of China, it seems inevitable taxes will rise in the future as it doesn’t look like there is the political will to cut spending as we could see with Starmers U Turns on the proposed welfare reforms with PIP payments forecast to rise to £27 billion, which is around a quarter of the education budget.
With budget deficits running at close to 5% or £74 bilion a year, which basically means the UK is spending more than it earns, and debt to GDP levels at 100% of GDP and interest payments servicing this debt at £107 billion or 3.90% of GDP, this makes for quite a depressing and sobering outlook on the state of the UK.
So we know the full state pension is £241.30 per week, but how much would the state pension cost if you tried to replicate this privately. One way to illustrate this is to look at what private pension fund would be needed to purchase an annuity, a guaranteed income, from an insurance company on the same basis as the state pension.
For a 66 year old male in good health looking to purchase an annuity of £12,547 payable for the rest of his life and increasing with RPI he would need a private pension pot of £225k.
Back to the question at hand, how does the UK state pension compare to the rest of the world. Just comparing the monetary amounts isn’t an apples to apples comparison as it will depend on other factors such as cost of living, healthcare costs and private pension provisions. To give a balanced and well rounded answer, we’re going to use a couple of ways of looking at this.
Global State Pensions vs Living Standards
The first of which is a study by Almond Financial which compares pension systems in all of Europe’s 50 countries against what income is needed to achieve a minimum standard cost of living. Each country is then ranked based on what percentage the pension payout is divided by the minimum cost of living in each country to make it an apples to apples comparison.
A score above 100% would suggest the state pension is above the minimum standard of living and a score below 100% would suggest the state pension isnt enough to cover basic living costs.
Take the UK for example, with a score of 121%, it sits in the middle of the road. It’s important to take the results with a grain of salt as for this study and table, the cost of living they have used is from the Numbeo data base and you could argue the minimum monthly standard of living needed of £810 for the UK sounds pretty low in my opinion.
An alternative measure which looks at what the average UK retiree would need for a minimum standard of living is by the Retirement Living Study and they find for a single person, the minimum required income is £14,400 a year or 1,200 a month which would mean the UK state pension rather than being above the breakeven point, is actually lower.
Spending on state pensions as a percentage of Gross Domestic Product (GDP)
Another method of assessing how generous or not the UK state pension is compared to its international peers is to look at how much each country contributes or pays in pensions as a percentage of Gross Domestic Product.
The OECD collects standardised data on each member country’s social expenditure on state pensions and pensioner benefits and you can see the latest results which are from 2020. As Europe is often seen as being quite socialist, it is no surprise to see many European countries top the list, with 6 countries spending more than 10% of GDP on pensions. How sustainable this is beyond my pay grade but take Spain for example, their central bank have said the country will need 25 million immigrants to help plug the labour gap and pay for pensions. Looking at the UK’s spending on pensions as a percentage of Gross Domestic Product at 4.7% a year, this is below the average for the OECD which is mostly developed nations.
A criticism of this approach is that the state pension is only one component of retirement income, and comparing this in isolation is of little value when you consider the UK has free health care, auto enrolment and more mature capital markets with for example defined contribution pensions, which are pensions either you and or your employer may pay in and the contributions are then invested and you can then eventually derive an income at retirement from the pension pot.
Take auto enrolment for eligible workers which as a minimum requires employers contribute 3% and individuals 5% of their earnings into workplace pensions.
Pension replacement rates compared to previous earnings
An alternative basis for comparison is pension replacement rates, which express a person’s pension income as a percentage of previous earnings from work. This illustrates the effectiveness of each country’s pension system at sustaining workers’ living standards as they enter retirement. The OECD’s biennial Pensions at a Glance report presents modelled pension replacement rates showing the hypothetical level of pension which people would receive in retirement if today’s pension rules remain unchanged.
The analysis is based on an individual entering the labour market at age 22 in 2022 and working as a private-sector employee until his/her normal pension age, earning either the national average wage, half this amount or twice this amount. The individual’s hypothetical pension is modelled using the national rules in place in 2022 plus future reforms that are agreed but yet to come into force.
Let’s take a look at the results. The analysis shows that the UK has an overall net replacement rate of 54% from mandatory pensions for an average earner, below the OECD average of 61% and the EU’s average of 68%.
State pensions compared to the average wage
To demonstrate this we’ll use the Netherlands, Ireland, Denmark and the UK state pension and compare them against the average wage in a straight shoot out. This research is taken from a government white paper. Let’s also take a look at how you qualify for each respective state pension. To qualify for the full state pension in Ireland, you need 48 qualifying years. In the Netherlands, the entitlement is based on residency, an individual accrues 2% of the full amount for each year he or she is a resident between age 15 and a maximum age of 50. A single person in the Netherlands gets up to 70% of the minimum wage and a couple can get the full maximum minimum wage.
Finally in Denmark, a basic amount is payable plus a supplement depending on if the recipient lives alone or is in a couple. A further payment is available for the poorest of society. Entitlement is also based on residency and the full amount is payable to those with 40 years of residency.
We can also compare the various state pensions both in cash terms and as a percentage of each countrys average wage and the conversion rates we use are based on April 2024. Looking at the results we can see that the Irish and UK state pension are not to dissimilar and Denmark’s is considerably better when you factor in all the means tested benefits .
When it comes to the Dutch state pension, for a pensioner who is married, the amount is worse than that of the UK, but for a single Dutch pensioner, it is better than the UK. Based on this test i’d give it a meh, it isn’t the best state pension but it isn’t the worst.
Another more holistic approach is to examine a countries percentage of its pensioners population living in relative poverty. Looking at the results the UK places 14 out of 34 for this test which is roughly in the middle.
How sustainable is each state pension?
Its all well and good a country having a huge state pension or an equivalent, but the question comes down to is it sustainable. Cast your mind back to the sovereign debt crisis of 2010 and Greece which in return for a £110 billion bail out as they were on the brink of default, the International Monetary Fund demanded various austerity measures included pension reforms such as raising the pension age.
The Mercer CFA Institute Global Pension Index is an annual cross-country comparison of various pension systems. The report scores and ranks the pension systems of over 40 countries, based on more than 50 indicators including adequacy, sustainability and integrity. An overall score of each country’s system is produced along with an associated grade. For a grade A, they define the pension system as having first class retirement income system that delivers good benefits and is sustainable. Looking at the results, the UK actually fares quite well and is awarded a B. Take some of the European countries which had scored well in the other tests such as Austria, Portugal and Turkey, when we factor this sustainability test in, they actually fare quite poorly.
Conclusion
Looking at these various measures and comparisons of the state pension, whilst the state pension isn’t one of the best, it isn’t the worst. To work out if the state pension is enough for your retirement, watch this video.
The value of investments and any income from them can fall as well as rise, and you may not get back the original amount invested. Past performance is not a guide to the future. HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen.
