Pensions Automatic Enrolment Inquiry

27 April 2016
Royal London’s Submission to the Work and Pensions Committee.

Executive Summary

Opt out rates from automatic enrolment workplace pensions are far lower than was initially anticipated. Royal London’s average opt out rates are lower than the industry average and opt outs are lowest among the youngest savers. 

The introduction of LISA requires young savers who would have been auto enrolled into their workplace scheme to make very difficult decisions. Inevitably if they have insufficient resources to save in both tax-advantaged vehicles then many more people will opt out of their workplace pension.  

The decision to opt out is likely not to be a good one. Royal London calculations show that for an average saver the employer’s contribution makes a significant difference in the value of retirement savings. The tax position in retirement of today’s 20 and 30 year olds cannot be predicted.

LISA could make a significant difference to the retirement savings of the self-employed.

Any financial guidance service should include guidance aimed at savers at the start of their savings journey. FCA should address issues of suitability around LISA and workplace pensions. 

There should be a delay in the introduction of LISA so that all employees have been through auto enrolment. Equally is should be a requirement that employees are making basic levels of workplace pension contribution before they can take out a LISA.

HMT should review the success of LISA in generating genuine new savings; not just redirecting savings from pensions or reallocating the savings from older generations more tax-efficiently. 

Introduction

Royal London has considerable experience of setting up automatic enrolment workplace pension schemes. As at the end of 2015 Royal London administered around 5,000 automatic enrolment schemes on behalf of 320,000 individual members. Royal London has won a number of awards for service and the quality of our workplace proposition. 

As a mutual provider we are entirely focused on achieving the best outcomes for members.

Opt Out Rates

1. Before the commencement of automatic enrolment DWP estimated an opt out rate among employees of 25-30%[1]. This estimate was subsequently revised downwards in the light of actual experience and two DWP qualitative research studies in 2012-3[2] and 2014[3]

2. The 2014 DWP study found opt out rates amongst those aged under 30 averaged around 7% whereas for those in the 50 plus age group opt outs averaged 23%. For Royal London the average opt out rate in the schemes we set up and run is currently around 8%.

3. The introduction of LISA will inevitably and adversely impact the opt out rates for this younger cohort of saver. The prospect of saving in a product which assists the purchase of a first home, through a generous Government bonus, will outweigh the longer term goal of saving for retirement. By launching LISA before auto enrolment has fully worked its way through the system (many employers are yet to stage) the Government is jeopardising a successful and widely-supported policy which is starting to address the widespread issue of inadequate retirement savings.

4. We would urge Government to delay the introduction of LISA until all employers have staged and auto enrolled their workforce to minimise the impact of increased opt outs. Equally it could be a requirement  that employees are contributing at least 5% of qualifying earnings to their work place pension before they become eligible for a LISA.  

The Impact of Lifetime ISA

5. The focus of LISA is on two specific life events; the purchase of a first home and the provision of a retirement income. This very specific focus introduces a very clear dilemma for those in the target group of savers between 18 and 40; should they go with the flow of policy intention and be automatically enrolled into the workplace pension or maximise savings for the deposit on a first home?

6. Many younger savers will find this a very difficult choice to make. In his Budget speech the Chancellor described the choice as “agonising”. The employer’s contribution makes remaining in a workplace pension an attractive option, but for many, the generous 25% match on contributions (up to £4,000) may be more attractive. For many the shorter term achievement of a deposit for a first home will outweigh the longer term goal of achieving an adequate retirement income. 

7. Younger people typically have less resources to draw upon and will now be forced into an either/or decision about the allocation of those resources; saving in a tax advantaged vehicle  either for a pension or a deposit on a home. Many will not have the means to make the economically rational decision to save in a workplace pension and a LISA.

8. There is no requirement to auto enrol young workers into the employer’s workplace pension until age 22. LISA is available to savers from age 18, so it is perfectly possible that an employee will have four years of LISA contributions topped up by the Government bonus in place before the question of workplace pension arises. Clearly many LISA savers will wish to continue with the course of action they have already embarked upon, choosing the LISA over the workplace pension alternative thereby losing the employer’s contribution.

9. There is a real risk that, having taken the decision to opt out of the workplace pension and save for a deposit in a LISA when first auto enrolled, that young saver will repeat this pattern of behaviour, opting out of each subsequent auto enrolment. Such people will fail to engage with the pension system until such time as it too late to accumulate a meaningful pot. 

10. It is also a realistic possibility that unscrupulous employers, faced with significant contributions into their workplace scheme, will actively encourage young employees to consider the alternative of a LISA, a product aimed at both house purchase and retirement income, backed by a generous bonus from the Government.

11. There is no indication that LISA will be subject to a charge cap in the way that auto enrolment workplace pension are subject to a charge capped at 0.75% p.a. In certain circumstances providers with an eye on profit margin may be tempted to prioritise LISA sales over thinner margins available on workplace pensions regardless of the comparative suitability of LISA.

12. The significant difference between the two savings vehicles competing for the attention of young savers, and the factor that makes workplace pensions suitable for most savers, is the employer’s contribution available. We have modelled this difference based on a person aged 22 earning £26,500 p.a. increasing by 2.5% p.a. We assume the minimum contribution into workplace pension of 8% of qualifying earnings (including an employer’s contribution). If the same person chose instead to save 5% of salary (4% after tax) into a LISA without the employer’s contribution but with the 25% Government bonus up until age 50 the differences are startling.

13. By age 60 the pensions saver would have accumulated a fund of £188,170, while the LISA saver’s fund would be £132,673 (a difference of 42%).  If the funds were held until the, then, State Pension Age of 68 the pension saver’s fund would be worth £298,820 and the LISA £206,360 (a difference of 45%).[4] 

14. This does not take into account the tax treatment of the two vehicles when they are converted into an income in retirement. The pension will be taxed at the individual’s marginal rate of tax while the LISA income, at least under current rules, is free from tax.  However with the income tax threshold at £11,000 (and rising) fewer pensioners will actual pay tax on their pension income. In making a decision about where to make retirement savings young savers will not be equipped to take into account the different tax treatments that apply. Nor can the average 20 year-old be expected to take a view on their tax position 40 or more years into the future.

The Impact on the Wider Economy

15. Those savers that opt out of a workplace pension in favour of LISA, and many will undoubtedly do so, will  delay saving for retirement  and divert savings into a house purchase. This means they will need to work longer before they can eventually retire. This causes problems for both employers and the wider economy. 

16. Employers cannot compulsorily retire employees and can only possibly dismiss them on grounds of capability. Employers don’t want to risk going down this route for fear of being taken to a tribunal. These older employees who now cannot afford to retire hold on to jobs excluding the next generation of younger aspiring employees from the workforce.

17. The introduction of LISA which potentially prioritises house purchases over saving for retirement has some far-reaching consequences for the wider economy stoking demand for housing which, in turn, will drive house price growth and inflation. Younger people who cannot get a job because the older generation cannot afford to retire will be reliant on unemployment benefits.

18. Although in announcing the LISA the Chancellor stated that he thought younger people had not received a “good deal from the pensions system”, the section of society that has really not benefitted from the system are the self-employed. By definition they do not benefit from any employer’s contribution, nor do they have a charge-capped pension scheme automatically available to them. In Royal London’s view the self-employed would be real beneficiaries from LISA with the 25% Government bonus for retirement savings held until age 60.

19. As a policy auto enrolment works because it does not require an active choice to be made by the saver. The introduction of LISA means that this will not always be the case for young savers for whom the emotional attraction of a first home purchase may outweigh saving for retirement in the workplace scheme. Sources of guidance (or advice) are not geared up to serve this part of the market and responsible employers will be wary of offering anything other than factual information for fear of subsequent sanction.

The Self-Employed

Guidance

20. HMT is in the midst of a consultation on “public financial guidance”. The proposed new “Pensions Guidance Body” should be given a clear remit to provide help for consumers at the start of their savings journey and not just in the run up to retirement (which is the case under current arrangements). To limit the impact of opt outs Government should delay launching LISA until staging is complete and every eligible employee has been through auto enrolment.

Recommendations

21. In order to ensure adequacy of retirement savings employees should be required to be contributing at least 5% of qualifying earnings to their workplace pension.    

22. The FCA should be required to lay out formally guidance on when LISA is a suitable option when there is the option of an employer’s contribution via a workplace pension. Specific risk warnings should also be considered.

23. After the first 12 months HMT should be required to commission a review into sales of LISAs to ascertain if this is genuine source of new savings and not just diverting savings from workplace pensions or, as seems probable, a more tax efficient means of sheltering gifts from parents and other relatives to fund the deposit on a first home. 

Last updated: 16 May 2016

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The Royal London Mutual Insurance Society Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered in England and Wales number 99064. Registered office: 55 Gracechurch Street, London EC3V 0RL.