Steve Webb, Director of Policy and External Communications
Our latest policy paper looks at the potential impact of the upcoming statutory phasing increase, and how to help your clients.
The first phase of automatic enrolment has been a huge success. One million employers have automatically enrolled around nine million workers into a workplace pension.
When it was initially designed and rolled out, there was widespread scepticism around uptake. The government expected a much higher opt out rate and predicted that one in three of those enrolled would leave the scheme. However, they were proved wrong; with an actual opt out rate at just one in ten.
But this is only the beginning. Contribution rates rise in April 2018 to a combined 5% (with a minimum 2% from the employer) and in April 2019 to a combined 8% (with a minimum 3% from the employer).
Any change can make people nervous. Will we see large-scale opt-outs which will mar the success of automatic enrolment and call into question the ‘soft compulsion’ on which the whole programme is based?
At Royal London, we think not.
In our latest paper ‘Will Britain take the next pension contribution increase in its stride?’ we argue that April 2018 and April 2019 will not cause a mass rush to opt out of workplace pensions. Despite the fact that household budgets are stretched, with real wages having seen little increase in the last decade, we believe that a number of factors will combine to keep pension scheme membership at a high level:
- The national living wage, which covers more than 1.5 million of the lowest paid workers in Britain, will be increased by 4.4% in April 2018. As a result the lowest paid workers, who might be thought to be most likely to opt out when contribution rates rise, will be guaranteed an increase in take-home pay.
- Income tax thresholds and National Insurance thresholds are increased in April of each year. Although this is sometimes only to keep pace with inflation, such increases will reduce the number of people who suffer a fall in take-home pay in April following the contribution rises. It seems reasonable to assume that an absolute pay cut would be far more likely to stimulate an opt-out than a nominal increase in take-home pay that is simply ‘lower than expected’.
- Millions of people get an annual pay rise in April. A pension contribution increase of 2% for workers equates to 1.6% after tax relief, so even pay rises below the rate of inflation could still more than offset the increase in pension contributions, especially where workers are only contributing over a band of ‘qualifying earnings’.
- Fundamentally, the power of inertia remains strong. Individuals will still have to actively opt out and the amounts they are being asked to contribute are still relatively modest. Evidence from the US suggests that when contributions into 401(k) workplace pension schemes were gradually increased by a few percentage points from low single digit rates, opt-out rates were very low, and the same is likely to happen in the UK.
Evidence in the US
Workplace 401(k) schemes have been in place for many years in America and there is substantial research already available on the impact of increasing contribution rates on participation rates.
In his book ‘Save More Tomorrow’ leading behavioural economist, Shlomo Benartzi describes a case study of a firm which moved from an opt in pension arrangement to one where workers were auto enrolled at a default contribution rate of 3%. A year later, the default contribution rate was set at 6%, though for new employees only. As expected, the move to auto enrolment dramatically increased pension scheme membership. But even more striking was that defaulting people in at 6% rather than at 3% had ‘almost no’ impact on opt out rates.
Whilst we cannot afford to be complacent, there is every reason to believe that the April 2018 and April 2019 automatic enrolment increases will pass off without incident and without undermining the fundamental viability of the automatic enrolment model.
The much more challenging question of getting people beyond 8% should not be delayed whilst we ‘wait and see’ what happens over the next 18 months.