State pension age: why changes could leave a hole in your pension

With the state pension age ever increasing, Alice Guy looks at what it could mean for you and why you might need to plug a hole in your pension provision.

The rise in state pension age is affecting most of us and could leave you short of cash in your 60s.

Recent research from the Institute for Fiscal Studies (IFS) shows that many people approaching retirement are struggling with their finances after the rise in state pension age.

The state pension age gradually climbed from 65 to 66 between December 2018 and October 2020. As a direct result, many older people have been caught short, as they still retired in the first half of their 60s. Thirty-three per cent of 65-year-olds were in paid employment in 2020: an increase of only 10% from 2018, the halcyon days when 65-year-olds still got their state pension.

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The state pension changes mean that most pensioners of 65 are down £142 per week, compared to their income before the state pension age uplift. Many 65-year-olds are struggling to make up the shortfall and an increasing number are facing poverty.

An IFS study found that among 65-year-olds under the state pension age, 25% are living in poverty, compared with 12% for those just over the state pension age.

Pensioners caught out by state pension changes

The state pension age increased from 65 to 66 in stages between December 2018 and October 2020. But many retirees were expecting to receive their state pension at 65 and had planned their retirement on that basis.

Rebecca O’Connor, head of pensions at interactive investor, commented that, “the IFS review largely refers to people who had already planned to give up work at 65 then realised this left them with a deficit as the state pension entitlement age moved further away from them”.

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O’Connor also explains that the bullish performance of the stock market in 2021 may have encouraged more people to retire early. “Until this year, the stock market was performing well - to the point where people were becoming almost complacent about their expectations of 5 to 7% a year growth from an investment portfolio. Healthy stock market growth meant that more people were able to successfully take an income from their pension pot without experiencing too much depletion. 

“As a result of these more benign [conditions] people might have felt more able to stop work, because gains in their pension pots would more than likely cover the one year between them giving up work and receiving the state pension. The general economic mood has also turned more pessimistic this year, and I fully expect that to translate into more caution among those approaching giving up work.”

When will you get the state pension?

So, when will you get the state pension? The answer depends on your age. If you’re 43 or under, you will have to wait until you’re 68 years old to receive the state pension and if you’re 60 you’ll only get the state pension when you turn 67. If you’re currently just over 43 or 60, you will need to check the state pension website as your state pension age will depend on your birthday.

And it’s possible that the state pension age will change again. A government review, due to report in May 2023, may recommend increasing it more quickly. The last review in 2017 suggested bringing forward the state pension age-changes to 2037-39, meaning that those who are now 50 would also have their state pension delayed until they turn 68

Hole in pension provision

There’s a hole in many pensioners’ finances in their early to mid-60s, as the state pension changes leave them struggling. Working in your late 60s is easier said than done and many people in their 50s and 60s have decided to take early retirement over the last few years.

In fact, a 2021 study by the Resolution Foundation showed that there are 1.9% fewer workers aged between 55-64 in the workplace than before the pandemic. And a recent ONS report found that more older workers are retiring due to illness, stress, a change of lifestyle, or simply not wanting to work anymore.

Without the state pension, those retiring early will lose £9,627 income per year, or £19,256 for a couple.

And even those with a private pension may face financial hardship for a few years. Many of us are expecting to take our private pension at 65. That’s fine as far as our private pension is concerned, but it could leave a funding gap as most of us are at least partly reliant on the state pension.

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For example, if you’re currently 60 and retire at 65, you will be wholly reliant on your private pension for two years. You may need to withdraw more from your pot than you’ve planned, and this could have a long-term impact on your investment wealth. It might mean your pension pot runs out once you’re older, or you have to live on a lower income than planned.

Withdrawing £38,000 from a pension pot of £200,000 could deplete your pension income by around £1,500 per year. That’s based on withdrawing 4% per year from your investment pot.

Future retirees are likely to work for longer

O’Connor believes that most future retirees, with longer to get our head around the changes, will end up working for longer. She comments that, “In general, most people do some form of work until they reach state pension age. The exception to this are if they happen to have income from other sources that allows them to retire earlier, or a particularly generous workplace pension arrangement.

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“That's because far and away, the state pension makes up the biggest proportion of retirement income for the bulk of retirees. Private pots, in most cases, don't even come close to replicating the level of income a state pension provides. The average pension pot among the over 55s, according to ii's Show Me My Money report, is £132,464. If you started taking an income from this at age 66 to last the next 20 years, it would generate an income of around £5,000 a year. 

So, the increasing age of eligibility is therefore the single biggest determinant of the age at which someone retires. Push it up, and more people will retire later.”

Important to plan ahead

If you’re facing an increased state pension age, then it’s important to plan ahead.

If you’re younger and a few years away from retirement, then you've got time to save more or change your plans to plug the gap. A couple would need to save an extra £19,500 to £58,800 to cover their lost state pension income.

O’Connor encourages investors to crunch the numbers, “Use the interactive investor drawdown calculator to work out how much you can take from your pension pot (remember to be realistic about your investment growth assumptions):

1) Assume you will live until at least the average age for a 65-year old man (83) or for a woman (86), although you can adjust these estimates according to knowledge of your own health and well-being. To play it safe, assuming you will live even longer, to 90 and beyond, is sensible. 

2) Once you have worked out how long your pot is likely to last, or how much income it will give you yearly over the time period, you can determine whether you can afford to take a bit more out in the early years to compensate for the extra year or two you won't have the state pension. It almost goes without saying that taking too much early on in retirement is a risky strategy.”