The Institute for Fiscal Studies (IFS) has called for a more targeted approach to extending automatic enrolment than simply increasing pension contributions.
The IFS pointed out that while auto-enrolment has “dramatically” increased private sector employees’ participation in pension saving, “key challenges remain” as most make low contributions.
A report produced by the institute as part of the UK’s Pensions Review in partnership with the abrdn Financial Fairness Trust has found that approximately 30% to 40% of private sector employees (5 to 7 million people) saving in defined contribution (DC) pension schemes are on course to having individual incomes that fall short of standard benchmarks in retirement.
However, instead of just raising the minimum pension contribution, the IFS said there should be a “more targeted approach” and affordability should be considered while reforming auto-enrolment.
One suggestion from the institute is that all employees should receive an employer contribution of at least 3% of total pay, irrespective of whether they contribute themselves. It said that this would benefit 22% of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to their earnings being too low.
The Institute also suggested that the age range should be expanded from 22 years old to state pension age, to 16-74 years old.
The Institute also suggested increased default employee contributions should be targeted at people on average incomes and above and for the government to raise the upper limit on qualifying earnings, which has been frozen at £50,270 (€69,600) since 2021–22, at least for minimum employee contributions.
Lastly, the IFS also suggested the government “future-proof” the system by indexing key parameters in the auto-enrolment system to average earnings growth, such as earnings triggers. It pointed out that the trigger is now 13% below the annual value of a full new state pension (£11,502), whereas on its introduction in 2012 it was 45% higher than the annual value of a full basic state pension.
In addition to the above suggestions, the IFS said that a set of reforms could be brought in to limit affordability concerns resulting from higher pension contributions.
This includes allowing those who face higher default contributions under the IFS recommendations a choice to “opt down” to the minimum pension contributions. It also suggested that, if the government implements legislation passed in 2023 which would increase default contributions by basing them on earnings from the ‘first pound’, it should give “serious consideration” to diverting the additional contributions initially into a liquid savings account, similar to the NEST ‘sidecar’ account.
Overall, the IFS calculated that implementing its suggestion would boost retirement incomes by between 12% and 16% (£1,400 to £2,100 per year) for those currently on track for low and middle incomes in retirement, while reducing the take-home pay of lower earners by a “small amount”.
David Sturrock, senior research economist at IFS and co-author of the report, said it is “really important” to take seriously the affordability of asking for bigger pension contributions from many low-earning individuals, as well as the need for many to save more.
“We suggest a way forward that would focus the encouragement of higher contributions on periods of life when people have average, or higher, earnings. Allowing people to opt down to lower contributions, or diverting some contributions into savings accounts, are also good options,” he noted.
He added that there is a “strong case” for almost all employees to receive an employer pension contribution, irrespective of whether they make a contribution themselves. He said: “That would be a bigger change to the system – and one that would likely be of particular benefit to many low earners.”
Mubin Haq, chief executive officer of the abrdn Financial Fairness Trust, added that guaranteeing 3% from the employer regardless of whether an employee makes a contribution “could boost employer pension contributions by £4bn per year”.
He said: “This would particularly benefit women, those working part-time, young adults and the low-paid.”
Nigel Peaple, chief policy counsel at the Pensions and Lifetime Savings Association (PLSA), said that the IFS proposals provide some “helpful ideas” and agreed that the government should consider how to help people, especially on low incomes, make “emergency savings”, possibly in a side-car mechanism.
“These issues should be considered as part of the government’s planned second phase of its Pensions Review,” he added.
Matt Calveley, director and DC specialist at Isio, noted that raising minimum contributions should be “phased in carefully”.
“Employers could increase their share first, eventually matching a 6% contribution from both sides. There should also be options for those who want to contribute more, with matching from employers, and the ability to direct savings into liquid accounts for those who need immediate access to funds,” he explained.
Calveley also noted that extending the age range for auto-enrolment is another “logical step” as people are working longer, and raising the upper earnings limit would allow higher earners to save more effectively.
However, he said that “simplicity should be maintained”, and any changes must avoid adding unnecessary complexity to the system. He also agreed with indexing the key thresholds, saying it would help “future-proof the system while ensuring it remains fair and inclusive for all workers.”
Sankar Mahalingham, managing director of pensions at Law Debenture, said the IFS recommendations make a “strong case” for expanding and enhancing the auto-enrolment system.
“It will be very interesting to see if and how the government responds; the pensions minister has made it clear that her focus for DC members is more on investment options and value for members rather than quantum of contributions, but with the Autumn Budget looming, it’s still all to play for,” he said.
Phoenix Insight’s recommendations
Last week, Phoenix Insight also published its recommendations for the government’s retirement adequacy review.
It called on the UK to further auto-enrolment by incrementally increasing contributions based on an agreed set of economic metrics and reconsidering the qualifying criteria in conjunction with any decisions to increase contribution rates.
In order to protect low earners, the think tank said the government should improve the flexibility of auto-enrolment by requiring employers to continue their contributions during opt-out and introducing sidecar products to allow emergency access to some contributions as well as launch pensions dashboards at the “earliest opportunity” and invest in their promotion.
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