Four changes needed to make auto-enrolment pension saving a success

The government has fired the starting gun on a scheduled review of one of the most important policies of recent years in pensions: automatic enrolment.

Conceived as a response to the chronic inadequacy of private pension saving, this policy requires eligible employees to be automatically enrolled into a qualifying pension scheme by their employer. Both the employee and employer must then make regular contributions.

Employees may opt out of this scheme within the first 3 months if they wish. However, only a small percentage (around 8%) of people have chosen to do so, so far. A much better figure than the 20% predicted. Millions more are saving into a pension, many for the first time.

So, does anything need to change in the 2017 review? In my view, yes. And quite a lot.

1. Increase the contributions
Today’s rates, at 1% of 'band earnings' (note this is different, and less, than total earnings) from each of the employer and employee, is no more than an irritation in terms of the eventual microscopic fund value it is likely to produce.

2. Put the obligation on the employer
Employees are currently asked to contribute 4% and the employer 3% (the balance coming from tax relief). This could be a policy design mistake, encouraging higher opt-out rates. In Australia, the best pensioned nation on earth, the obligation has always been on the employer to make the contribution. Employees are encouraged to contribute and they do, heavily. The average combined contribution for 2016 is expected to be around 16% of total earnings. It is this kind of figure we need to be aiming at in the UK.

3. Include more people in the scheme
Between a third and a half of potential employee savers currently fall outside the eligibility criteria. They are too young, or too old, or don’t earn enough. This last criterion ignores those with multiple part-time jobs, for example. We also need to find a way of including the nearly 5 million self-employed who are also not in scope, especially as estimates suggest that less than one in five of these people are not saving anything at all for retirement.

4. Simplify the rules
We need to streamline and simplify the rule-set for employers. Companies I’ve spoken to are comfortable with making pension contributions for their staff, and quite a few are contributing more than the statutory minimum. However, most have found the administrative rule-set around 'eligible job-holder', 'entitled workers' and band earnings very complex, hugely costly and almost designed to trip up even the willing and well-resourced.

So, there is quite a lot to do if we are to truly transform the retirement prospects of the UK population.

To be fair, it is clear that the government recognises many of these challenges and is apparently keen to try to resolve them. I think the solutions are potentially there for all of these problems, but some changes to primary legislation may be required. The emphasis needs to be on simplicity. My sense is that employers are prepared to help. But ultimately, getting to where we need to be will be a test of political resolve.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Malcolm's views are his own and do not constitute financial advice.
Published on 22/02/2017