Rethinking pension contribution levels

There really is no shortage of pension changes on the horizon. Those of us who have worked in the sector for a while will be used to that, but perhaps not on the scale currently proposed.

The Pension Schemes Bill itself signals a seismic shift by introducing new asset thresholds, meaning fewer, larger providers. It will introduce a new Value for Money framework, new requirements for schemes to offer more support at retirement, consolidation of small pots, alongside the framework for Collective DC schemes and surplus release rules for Defined Benefit schemes.

And the power to mandate investment has arguably been the most contentious proposal of all, a debate which may run on beyond the Bill’s passage through parliament.

Policy developments shaping pensions

Aside from the Bill, the Pensions Dashboard is expected to launch next year, allowing people to find and value their various pensions online. No-one yet knows what engagement this will drive among pension savers; whether it will positively inspire people to review their retirement prospects or simply be met with the very apathy that has driven the success of automatic enrolment.

On the tax front, we have changes to include pensions in IHT from April 2027, an increase in the minimum pension age from April 2028 and a reduction in salary sacrifice savings from April 2029. There is still detail to finalise for each of these changes, and another Budget due before any of them take effect.

Amidst all of that, it would be easy to forget that we also have a new Pensions Commission, tasked with the ‘bigger questions’ on pensions reform, looking at what future provision should be for the generations to come.

The pension savings gap

One of those questions is, arguably, the most important of all; are we saving enough for retirement?

At a time when both businesses and households face significant cost challenges, it seems perverse to suggest increasing pension contributions, and there is widespread acceptance that now is not the right time to do so.

Implications for savers and the wider economy

However, if we are facing an increasing number of under-saved people in retirement who are unable to work, whose tax contribution is minimal, and who rely more heavily on state benefits, this will inevitably place a greater tax burden on the working population.

In short, the cost of business and cost of living challenges today may be further compounded in the future.

The new Pensions Commission provides us with an opportunity to consider the question of contribution adequacy in an independent context.

Automatic enrolment has undoubtedly been a huge policy success, significantly expanding coverage of pension saving across the UK. However, it is widely accepted that the minimum contribution levels under the current system are inadequate.

Quite apart from the obvious impact on people’s lifestyle in retirement, and the challenges this brings for them and their families, there is a wider macroeconomic problem which will only become more difficult to resolve the longer we put it off. Achieving an adequate level of retirement savings takes time, measurable in decades.

Assessing higher contribution levels

Royal London commissioned Oxford Economics to model the impact of increasing minimum contributions to different levels. The modelling also looks at the impact of changes proposed in the 2017 Review of Automatic Enrolment – but not yet implemented – namely, lowering the minimum age from 22 to 18 and removing the lower earnings limit when calculating contributions.

The report sets out the positive difference this can make for households in reaching Target Replacement Rates and indeed the income thresholds needed under the Retirement Living Standards, produced by Pensions UK.

In essence, it shows how increasing contributions to different levels can help bolster the number of households living comfortably in retirement.

But the analysis also demonstrates the challenges in making some of these changes, particularly for lower paid employees, whose disposable income may already be very low.

How higher pension savings affects the economy

Importantly, the modelling also includes the projected impact on the UK’s economic outlook, specifically how increasing pension contributions affects growth. It takes account of commitments made by pension providers to invest more in UK assets associated with driving economic growth, namely the Mansion House Accord and Sterling 20 initiatives.

As you might expect, there is a modest dampening of growth in the early years as money is taken out of circulation to invest in pensions, but that quickly turns positive as the money starts to work harder, both in investment terms but also in providing spending power to pensioners.

And of course, the two things are entirely connected. Living standards in retirement are likely to be more favourable in a growing economy.

Considerations for advisers and employers

Many large firms will already be contributing above the minimum levels stated under automatic enrolment or offer matching contribution options that incentivise people to save more. It will be more difficult for many smaller firms, and indeed for lower paid people, and that should of course be part of the debate – how we ensure changes are fair and proportionate for all.

We should also consider the timetable over which changes could be phased in, and perhaps the threshold for economic indicators in any given year that dictate whether to proceed with increases or pause them. In essence, this is how Australia has reached a 12% contribution rate over several decades of incremental change.

The long-term outlook

Long term, increasing retirement saving should be a win-win for businesses and households alike. This may not be the right time to make that leap, but developing consensus can take years, so we would do well to start planning now.