Radical plans to let employees overrule their employers on workplace pensions risk tearing up the rules around automatic enrolment, Money Marketing can reveal.
The Government is exploring reforms that will see staff pick their own auto-enrolment scheme, with the aim of drastically reducing the number of small pension pots and at the same time boosting engagement among savers.
But there are also fears the move, if adopted, could sever the link between employers and employees and leave savers at the mercy of the open market.
Providers argue such a move would be “fundamentally misconceived” and a “mistake” that could undermine auto-enrolment at a crucial stage.
So should the Government really start tinkering with auto-enrolment with two years still to run before all eligible workers are covered?
Is this new idea to cut the number of orphan savings better than pot follows member, the coalition’s controversial proposal scrapped by the Conservatives last year?
And will giving staff a greater choice over their pension provider boost understanding or simply increase the likelihood of people going into unsuitable products?
“This is a mistake. For auto-enrolment to be successful the key is the employer contribution, so don’t break that link”
The pensions industry has long been grappling with a solution for the small pots problem, where millions of pounds of pensions savings are left behind when people switch jobs.
In 2011, research from Department for Work and Pensions predicted the number of pots below £2,000 would reach 4.7 million by 2050.
According to previous Government research, the average person works for 11 employers during their life, with a quarter working for 14 or more.
The DWP warned the proliferation of small pots means consumers lose out through higher fees as a result of firms administering so many pots; there is a lack of engagement as people lose or are unaware of savings; and potential problems exist in transferring such small amounts.
In response, former pensions minister Steve Webb backed the pot follows member model, where savings below £10,000 are automatically transferred when an employee switches jobs.
However – as revealed by Money Marketing in September – Webb’s successor Ros Altmann shelved the plans as “not an immediate priority”.
Few details have emerged but it is understood various Government departments and senior pensions industry figures have discussed letting individual staff chose their auto-enrolment scheme.
In theory this would allow savers to have the same pension provider throughout their career, drastically reducing the number of pots created.
Under current auto-enrolment rules, employers can offer to put staff contributions into schemes that are not qualifying schemes. However, they must make an active choice and are re-enrolled into the employer’s chosen auto-enrolment scheme every three years. But not all firms give staff the option.
The proposals are being seen by some as a logical extension of George Osborne’s pension freedoms, handing even greater autonomy to individuals, with the aim of boosting engagement with long-term savings.
Altus director Ben Cocks sees the potential in a scheme follows member model.
He says: “The idea an employee can choose the pension to which their employer contributions are paid is good in theory. It allows employees to maintain a single pension even when they frequently move jobs. It gives them choice over which provider to use, regardless of what their employer thinks.
“And as a result of that choice it encourages competition between providers.”
“One might even argue that scheme follows member is necessary in the new pension landscape.
“Engaged pension savers would be well served by pension freedoms and scheme follows member; unengaged employees would be nudged along by auto-enrolment and some successor to pot follows member for small pot aggregation; and a pension dashboard would help the unengaged to begin to engage. It’s almost as if this was all planned from the outset.”
Hargreaves Lansdown head of retirement policy Tom McPhail says: “Last summer we wrote to the Treasury proposing a modification of the auto-enrolment programme, to put individuals at the heart of the pension system.
“We proposed giving employees the right to choose their own pension into which their employer contributions would be paid. We argued this could help solve both the small pots and the member engagement problems and could build a bridge between auto-enrolment and the pension freedoms.”
Breaking the employer link
The Government’s flagship savings programme works on the principle that employers, with their greater resources, choose a scheme that suits the profile of their workforce. Providers have also based their pricing on the expected increase in business as auto-enrolment is rolled out.
Provider Now: Pensions estimates the size of pension pots could be cut by between 5 and 10 per cent if the option is introduced.
Chief executive Morten Nilsson says: “Where the individual is choosing, there is a greater danger that they won’t get value for money.
“In recent years much has been done to safeguard quality in workplace pension schemes but much of this benefit could be lost.
“By undermining collectivism and increasing complexity, charges will also inevitably increase. While auto-enrolment default funds are subject to a charge cap, savers taking their money elsewhere could find their savings rapidly eroded by charges. A typical charge in a Sipp, for example, is 1.5 per cent versus the charge cap of 0.75 per cent.
“Not only would those that leave to go to exotic Sipps pay higher charges, the effect of cherrypicking will drive up charges for those that remain in the workplace scheme.”
Webb, now Royal London director of policy, says: “It is hard to see how this solves small pots. We know auto-enrolment works by inertia. So if an employer has a main or default scheme most people will presumably stay there.
“And they will do the same in their next job and so on. But if employers don’t have a main scheme and every individual worker has to choose an individual scheme, how would that work? And what would that mean for the economies of scale that are a key part of auto-enrolment?”
He says if the Government has capacity to make changes, the priority should be raising contributions above 8 per cent.
Aegon head of pensions Kate Smith warns cutting out employers could spell disaster. She says: “This is a mistake. For auto-enrolment to be successful the key is the employer contribution, so don’t break that link. Employers make that payment and they also help bridge the advice gap – they are the best chance of boosting engagement and getting messages out.
“Employers also need to know member information, who is opting out or upping contributions. It breaks engagement, there is no chance whatsoever of it working.”
Others say employers could be overwhelmed if they have to send contributions to multiple providers.
AJ Bell head of technical resources Gareth James says: “Expanding retirement choices through auto-enrolment could increase the scope of the reforms and would undoubtedly be viewed as a positive by many employees. However, policymakers would need to ensure smaller employers – upon whom auto-enrolment’s success depends – do not become disengaged because of any additional burden this might place on their shoulders.”
One of the recommendations of the Financial Advice Market Review, published jointly by the FCA and the Treasury, was for the industry to produce a digital pensions dashboard by 2019.
Many see this as a more effective method of engaging people with the added benefit of cutting down the number of transfers needed under both the pot follows member and scheme follows member models.
Smith adds: “Hopefully by the time the dashboard is built, and the FCA has sorted out ease of transfers and the other issues, people will be more empowered to make decisions. So the consumer sees all their pots and can then make a decision about whether to consolidate them or not.”
A government spokesman says: “Auto-enrolment has already been a huge success with over six million new people saving into a workplace pension. We are focussed on rolling the programme out to millions of small employers to give more workers the chance to save towards their retirement.
“This government is challenging the industry to make a pensions dashboard available to consumers by 2019 so that people can more easily engage with their pension savings.”