Now my series of posts explaining the UK pensions landscape has been completed, it’s time to address which issues need to be resolved to ensure pension schemes offer the best possible future to their members.
In this post I explained how the UK government took a careful approach to auto-enrolling employees into schemes with contributions slowly phased. Ratcheting up levels gradually ensured employees were not spooked and did not opt out.
That policy resulted in the number of active members of private sector defined contribution occupational schemes growing rapidly from its low of 2.7 million in 2011 to 9.9 million in 2018.
But there are questions whether the current contribution levels of 8% of salaries – made up of 5% from salary packets and a minimum level of 3% of employer contributions – will be enough to ensure pension pots can provide sufficient income at retirement.
These levels are not arbitrary. The Pension Commission opted for a target of 8% of salary in order to get employees to a minimum income replacement target.
The problem is few scheme members are aware this goal was the target and instead assume their DC will be enough to achieve a comfortable retirement. If employers and the government want scheme members to have an adequate income as pensioners then higher contributions levels are required.
There is considerable debate about the ideal amount to save into a pension as there are many moving parts affecting the amount needed to be saved. What returns will your DC pot make? When do you want to retire? How much annual income do you need? How long will you live?
The Pensions and Life Times Savings Association recently tried to address this tricky question by laying out some possible retirement income scenarios in this document. And Aviva has teamed up with The Resolution Foundation to introduce the concept of a Living Pension – a mirror of the Living Wage – with the aim of helping focus on companies to focus on how a decent retirement can be reached.
These scenarios and targets can help individuals and companies to envision what is needed to provide a comfortable life after work, which should then help to answer the question about how large contributions need to be to achieve these goals. The Independent Review of Retirement Income report came to the conclusion 15% of our lifetime earnings should be paid into a pension.
Scheme members could opt to pay another 7% of their salaries into their pension over their working life to give themselves a better chance of a comfortable retirement. But we know that people are unlikely to value long-term benefits over short-term needs. This is why auto-enrolment uses an opt-out rather than an opt-in.
Auto-escalation is the answer
It would be better to have an auto-escalation policy. This could either be linked to salary increases or could it mimic the staging process and happen over time. It would need to be gradual because a rapid escalation in contribution levels could spook scheme members and cause them to opt. If we want to hit the 15% lifetime earnings target, that could mean paying more than that to reach that goal.
While there is nothing to stop companies from putting this in place, government policy would ensure much higher levels of compliance and a growing majority of the working population receives the same benefits.
But up to now the government has shied away from increasing contribution levels. The aftermath of the pandemic and Brexit will provide more excuses for a lack of action as it will be argued such increases will be tough to bear during a time of economic downturn. Action will be needed, however, to ensure auto-enrolment fulfils its implicit aim of providing an adequate retirement.