The Government should steer clear of boosting automatic enrolment contributions as part of an imminent set piece review of the flagship saving programme.
So say the authors of a landmark 2010 report that shaped the rollout of auto-enrolment as they reflect on the changing needs of savers and the market in the intervening six years.
Money Marketing spoke to Institute of Fiscal Studies director Paul Johnson, United Nations Staff Management Committee president David Yeandle and Tisa, Now: Pensions and Dunstan Thomas director Adrian Boulding.
All three were commissioned by the Department for Work and Pensions to pen the influential Making Automatic Enrolment Work report ahead of the 2012 launch of the programme.
However since then the nature of the workforce and savings landscape has been redrawn. The introduction of the pension freedoms, launch of the Lifetime Isa and spiralling cost of the state pension mean the foundations of auto-enrolment must be reassessed.
The Government is compelled by legislation to carry out its own review in 2017.
Three key areas are expected to be investigated: whether auto-enrolment covers the right people, the adequacy of contribution rates, and if savers’ pension cash is getting value for money.
In addition, the role of Government-backed provider Nest is also up for debate as the restrictions placed on the scheme are lifted next year.
Six years on
Six years after the report was published – and four since the first employees began being auto-enrolled – the pensions landscape is unrecognisable.
Not only has the UK emerged from a recession but the Government has wrought radical changes that give savers unfettered access to their points, in a clear move away from the inertia principles auto-enrolment was founded on.
Under current rules, savers are auto-enrolled when they earn £10,000 or more a year. Employee and employer contributions are then based on a band of earnings between £5,824 and £43,000.
The legal minimum contribution is 2 per cent, including 1 per cent from the saver, up to April 2018.
This then rises to 5 per cent (3 per cent staff contribution), then 8 per cent (5 per cent from staff) from April 2019 onwards.
However, there is widespread belief that even at 8 per cent most people will fall short. Research from the Pensions Policy Institute shows there is a less than even (49 per cent) chance of an average earner with full state pension hits the target replacement rate of 67 per cent.
Director Chris Curry warns this drops to just a one in four chance if the Government scraps the triple lock on state pension increases and raised payments simply in line with earnings.
Despite this dire warning, Johnson, Yeandle and Boulding say the Government should hold fire on raising contributions further.
Johnson says: “When we did the review in 2010 the expectation was earnings would start rising again over the last few years but they haven’t. Earnings are still below where they were pre-recession, which is shocking.
“So the tolerance for higher contributions both for individuals and economy-wide given how general pay growth has been, is much more limited than you would have expected six years ago.
“It would be very difficult to talk about putting more into auto-enrolment scheme with this macro-economic backdrop.”
Boulding adds: “Increasingly I think this review isn’t the time to raise contributions above 8 per cent, because we don’t reach that level until April 2019. We don’t have any data on whether it will prompt people to opt out or not.
“This review should signpost when the next review will be, which I think should be summer 2020. Then we’ll have a full year’s data and we’ll have a newly elected Government, the date should be pegged in statute like the 2017 review was.”
Yeandle warns it will take “clever political manoeuvring” to go beyond 8 per cent.
He says: “It’s not too soon to start having the debate but it may be too soon to start implementing – remember it has taken 12 years to get from zero to 8 per cent. It will take a bit of pressure and clever political manoeuvring to get employers on board for higher contributions, it was a hard task to get to where we are now.”
However, the pensions industry is more bullish.
Master trust Smart Pension wants minimum contributions jump to 10 per cent in 2020, 12 per cent in 2022 and 15 per cent by 2025, while Hargreaves Lansdown is calling for 12 per cent by 2023.
Royal London chief executive Phil Loney is urging the Government to go further. He suggests new rules that automatically take a proportion of pay rises and put them into pension pots, known as auto-escalation.
He says: “You can’t just mandate a jump to say 15 per cent, we’d like to see steps taken to bring legislation in to make a default approach making sure a small percentage of each future pay rise is defaulted into your pension.
“We want legislation to set auto-escalation as the default approach, we can’t just leave it to employers to do that. We need to continue in the spirit of auto-enrolment that nudges people in the right direction – something like 25 or 30 per cent being diverted.”
Loney warns that without urgent action the Government would have to “institutionalise” the triple lock to sustain decent retirement incomes, leading to even greater costs to the state as society ages.
However, Aegon head of pensions Kate Smith says the Government, industry and regulators should focus on engagement to boost savings.
She adds: “Ideally I would like to see average DC contributions doubling by 2025, but via engagement rather than force.”
In addition to inadequate savings rates, millions of workers are not saving at all. To date around six million people have begun savings through auto-enrolment but roughly the same number have been excluded after being assessed.
And the growing number of self-employed workers – which now make up 15 per cent of the workforce – only add to that number.
Former pensions minister Steve Webb argued while lowering the trigger and banded earnings threshold would bring more people into the system, the amounts being saved would amount to pennies.
But Boulding says: “When we did the review we went to pains to see that people who went over the lower threshold but were under the trigger could receive the employer contribution if they wished to. But on the ground we’re seeing that very few of them have taken up the offer and joined the scheme.
“So the number one issue is to address the millions of people locked out so far and look at those definitions of who gets auto-enrolled and who doesn’t, bring more of them into the fold.
“Lowering the bands is the easiest way to do it, I don’t think lowering the age below 22 is the right thing to do.”
He adds the growth in the number of people with part-time jobs since the recession needs to be addressed. Under the current structure, contributions are based on a band of earnings on each job, so they lose out on contributions on the first £5,824 of each additional job.
Pensions minister Baroness Altmann told Money Marketing: “Another issue to address is how we can extend coverage to bring more low earners and women into scope, in order to help as many people as possible to benefit from the opportunity to save into a workplace pension, as well as ensuring charges are fair and fully disclosed.
She adds: “The 2017 review of auto-enrolment will be an important step in planning the future for this vital programme in UK pension provision. I intend to use the opportunity of the 2017 Review to consider broadly how best to build on the success so far, as well as improving consumer engagement, coverage and adequacy.”
Rowley Turton director Scott Gallacher says: “Ideally, I’d get rid of the bands – I’d auto-enrol everyone. You end up with a bizarre anomaly with someone on £25,000 will get a decent pot but someone with five jobs earning the same amount will get nothing. At the moment part-time workers and carers are being penalised. I’d also bring the age down from 22 to 16, the advantages of starting earlier are massive. Contributions will have to go up in due course. Realistically the long term goal should be 10 to 15 per cent of total earnings. How quickly that’s done is hard to say, you don’t want to put people off. If you drag it out long enough it will just get absorbed – this should always have been in legislation when we started then no-one would have noticed.”
Dire earnings growth puts paid to contribution increases
The problem with the 2017 review that we won’t have people putting in the equilibrium amount. So it feels too early to be saying that amount should be increased given that we won’t have even reached it. If I was Government I would want to wait until it’s bedded down at the full current intended contribution rate until at last a couple of years.
Earnings are still below where they were pre-recession, which is shocking. So the tolerance for higher contributions both for individuals and economy-wide given how general pay growth has been, is much more limited than you would have expected six years ago. To talk about more going into AE schemes is difficult with this macro-economic backdrop.
A lot of the complexity in auto-enrolment comes from the fact we do not have compulsion. I’m not saying you should make the system compulsory but that would remove a lot of the complexity. Given how low opt-out rates have been you would have got something awfully similar but with a lot less hassle. It is the choice element that makes it so difficult for employers.
On the self-employed now they are accruing full rights under the single tier state pension there’s a strong case for charging them additional National Insurance – it’s extraordinary we’re not doing that.
Nest doesn’t meet the simple charge cap methodology itself. It’s a horrible thing to get into, because the hidden charges are incredibly difficult to get to the bottom of certainly as a customer. Charges must be looked at because they matter so much in the long run. And for Nest particularly you should be looking at whether the default fund should be looked at again, as so many people are putting their money there. It’s a huge choice being made for millions of people.
Paul Johnson is director of the Institute for Fiscal Studies
We need to decide on the who, what and why as soon as possible
There are a lot of questions to answer. We need to start the conversation sooner rather than later – the how, who and what the review will cover. Once the political dust has settled after the referendum we can start to focus. Two big changes – the pension freedoms and the introduction of the Lifetime Isa. I hope whatever happens we move back to evidence-based policy making we saw with the Pension Commission and our report.
And it’s important to remember the legislation only says the Government has to review auto-enrolment – there is no technical requirement to actually do anything. There are two options for the review itself – you could have a comprehensive review looking at a broad sweep of things, or focus entirely on auto-enrolment. Adequacy will be the key focus of the latter, we need to get more going into schemes. It’s not too soon to start having the debate but it may be too soon to start implementing – remember it has taken 12 years to get from zero to 8 per cent. It will take a bit of pressure and clever political manoeuvring to get employers on board for high contributions, it was a hard task to get to where we are now.
There are all sort of aspects that need to be looked at – self-employed, people on modest incomes but multiple employers, do we focus on the bands of earnings – this requires serious debate. And there is the way it is implemented, it could be done entirely within the DWP, or like our review where a group of experts are appointed to work with civil servants, or you could do something more grand like a Pension Commission Mark II.
David Yeandle is president of the United Nations Staff Management Committee, director of European Employers Group and sits on the Nest Employers Panel
Bring in lower earners
A lot of water is under the bridge since the review, there’s around 6.5 million in and another 3 million to go. That’s a huge success but there are around 5 million excluded so far who have been assessed by employers and chucked out.
The number one issue is to address the people out so far and look at those definitions of who gets auto-enrolled and who doesn’t and bring more of them into the fold.
Secondly, we need to look at the lower band. What worries me about this and it’s something that we didn’t foresee, is there are a lot of people with two part-time jobs.
Third thing is how we get 8 per cent up. Increasingly I think this review isn’t the time to do that, because we don’t reach 8 per cent until April 2019. So we don’t have any data on whether it will prompt people to opt out or not. This review should signpost when the next review will be, which I think should be summer 2020. Then we’ll have a full year’s data and we’ll have a newly elected Government. It should be pegged in statute like the 2017 review.
The review should also question the financing of Nest in terms the size of the subsidy it is given, and the very low interest rate. Is that something that is really getting the taxpayers value at the moment? If not is there something we can do to reduce the loan and get it off the balance sheet?
Adrian Boulding is a director at Dunstan Thomas, Tisa and Now: Pensions