Thousands of elderly people are struggling to cope with everyday tasks at home because a £500m funding shortfall has left them without the care they need, the charity Age UK warns.

Spending on older people's social care in England this year has fallen short of even maintaining the "inadequate" levels of provision in place when the Coalition came to power, a report by the charity argues.

To maintain the same levels of service as in 2010, the report's projections show that the Government needs to spend £7.8bn this year. In fact, councils have only budgeted £7.3bn in the face of cuts in central government funding.

Age UK's analysis, called Care in Crisis 2012, shows that the combined impact of growing demand for services and a £341m reduction in older people's social care budgets this financial year – equivalent to a 4.5 per cent cut – has created the £500m shortfall.

Since 2004, the number of people aged over 85 has risen by more than 250,000. The increasing demand, combined with a fall in real-terms spending, has created a funding crisis.

Age UK projects that, by next year (2012-13) the Government will need to spend £1bn more than this year to stop the situation deteriorating further.

Its report shows that of the two million older people who need care, almost 800,000, nearly 40 per cent, do not receive any formal support. The total hours of care support purchased by local authorities for older people decreased from two million to 1.85 million in 2009-10. Since 2009-10, local authorities have faced funding cuts of 28 per cent over four years.

In 2005, around half of councils provided support to people assessed as having "moderate" care needs, but by 2011 the figure had fallen to 18 per cent.

Michelle Mitchell, charity director of Age UK, said: "Our new figures show a funding gap clearly exists, that it currently stands at £500m, and that it is growing bigger all the time. We need urgent government action now; otherwise the gap will simply get worse.

"Behind these figures are real older people struggling to cope without the support they need, compromising their dignity and safety on a daily basis ... it is the support that helps older people get out of bed, feed themselves, have a wash, live a life that is more than just an existence."

Funding for adult social care has become a hugely controversial issue. The Dilnot commission last year concluded that the current system was unfair and unsustainable.

It recommended that individuals' lifetime contributions towards their social care costs – which are currently potentially unlimited – should be capped at £35,000 and the means-tested threshold, above which people are liable for their full care costs, should be increased from £23,250 to £100,000.

The Government has promised to publish a White Paper on the issue in the spring. Paul Burstow, the Care Services minister, said: "We agree with Age UK that the social care system is broken and needs to change. The system must become more joined-up with health and more focused on helping people maintain their independence for as long as possible ... We are investing more money in social care. At the spending review, we committed an extra £7.2bn over four years."

'It would have cost the state less to support her in the flat she loved'

Kathleen James, 87, had hoped to spend the rest of her life in the Eastbourne flat she loved. But as her health deteriorated, she began to need help with basic tasks.

Her local council assessed her support needs as being only 32 minutes a day. Two years ago, Mrs James decided she could not continue in her own home. Her son, Martin Baker, 61, said: "It wasn't what we wanted to do but there was no other way."

Now in a care home in Reigate, Mrs James pays her own care home fees but has an NHS nursing care allowance of £472 a month towards her nursing care. Mr Baker says it would have cost much less to support his mother to remain in her flat.

He said: "My mother had to sell her flat to buy an annuity to pay the care home fees and now has almost no money at all.

"She had to part with many of her treasured possessions because there was no room in the home. If she could only have been given the extra help she needed, I am sure she would have been able to stay in the home she loved – and it would have also cost the state much less money."