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‘The 8% question’: Politicians must address auto-enrol pensions adequacy challenge

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“At some point a future Government will have to deal with the great ‘8 per cent is not enough’ question. Arithmetically 8 per cent is not enough for lots of people but how do you fix that?

“I have some thoughts but that will be a big challenge for the next Government.”

Pensions minister Steve Webb, 3 April 2014

The Budget was the easy bit.

Handing savers greater freedom over how they spend their pension pot was always going to play well with the electorate.

Ask 100 people if they would like to be trusted with their own money and almost all of them will say yes (although whether they are confident about making complicated retirement decisions unaided is another matter). The idea of having more control, flexibility and freedom is instinctively attractive.

But the next Government will face the much more important and less politically appealing decision of how and when to increase auto-enrolment minimum contributions above 8 per cent.

According to analysis from Hargreaves Lansdown, a 22 year old with qualifying earnings of £30,000 who contributes 8 per cent and retires at age 68 would receive total combined state and private pension income of £16,613, or 55 per cent of their working salary.

A 35 year old on the same salary would receive total pension income of just £11,697, or 39 per cent of salary.

The issue of adequacy is one Steve Webb, the Liberal Democrat pensions minister, told me last month he is beginning to ponder ahead of next year’s general election.

The challenge facing policymakers is both practical and political. How do you increase contributions without, a) causing a surge in opt-outs, and, b) becoming unpopular with voters?

Hargreaves Lansdown head of pensions research Tom McPhail says achieving cross-party consensus will be crucial in pushing through future contribution increases.

He suggests auto-escalation – where employees’ pension contributions are automatically ratcheted up when they receive a pay rise – could be successful in the UK.

“Auto-escalation seems like a very logical response to the problem of insufficient pension contributions,” McPhail says.

“But you can drive a lot of good behaviour through communication and engagement and that is something we will be talking to the next government about.

“I think if we can get to a place where 12 per cent is the auto-enrolment minimum that would be a good outcome.”

While attractive in principle, auto-escalation should not be seen as some sort of pill that can cure the auto-enrolment adequacy problem.

B&CE head of policy Darren Philp says: “Contributions have to go up and a lot of the research suggests we need to be moving to 15 or even 20 per cent.

“I like the idea of auto-escalation but that should be for people who want to save more than the minimum. I wouldn’t have it as a default.

“If you use auto-escalation to increase minimum contributions you will get quite disparate results across the workforce. Different companies have different pay rises and the reality is over the past few years a lot of people haven’t had pay rises at all.

“The risk is that it will not be equitable.”

While a consensus around the importance of increasing contributions is building, it remains uncertain how this should be done. Will employers continue to pay in around half of the employee’s total contribution? If so, how will a contribution rise impact on the business community and the wider economy?

With an estimated 9 million people expected to be auto-enrolled into a pension scheme by 2018, it is hard to argue the early stages of the reforms have been anything other than a success.

But if public pensions policy is to be successful in ensuring people save enough money to enjoy a comfortable retirement, the thorny issue of raising contributions will need to be addressed.

Tom Selby is deputy head of news at Money Marketing – follow him on twitter here

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  1. You fix that by having a decent State Pension. We pay the worst in the OECD and are also the highest taxed. AE is nothing but another tax.

    Perhaps the Government (any Government) needs to reassess its priorities.

    How important is it (for example) to pay over £11 billion in Foreign Aid if you can’t afford to pay decent pensions? Yes the retirement age needs to be 70. But there are all sorts of economies and adjustments that can be made before squeezing those who can least afford it.

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