Sidecars could hold key to short-term savings problem

It is a dramatic change from the days when workers had to proactively ask to join their workplace pension scheme – that is if there was one of course.

As an industry, however, there is certainly more for us to do when it comes to improving people’s overall financial wellbeing. While many more are now saving towards a more comfortable later life, some are struggling with day-to-day finances.

Work by the Money Advice Service highlights this situation. Their research found that of the UK working population, only 42 per cent have £500 or more in liquid savings and 26 per cent have nothing.

Income shocks pose real threat

For people with little or no liquid savings, the occurrence of a high and unexpected cost can have a severe impact.

It may be that their car or a household appliance breaks down and needs replacing; everyday situations we have all faced.

But, without cash savings, many will have no choice but to use alternative methods to cover the expense. Some will seek to borrow money from friends and family, use existing sources of credit such as credit cards, or reduce their spending where possible.

Others, however, may have to choose more detrimental methods. They might cancel pension contributions to free up cash, or turn to higher-cost sources of borrowing which, if not managed carefully, could lead to debt spirals.

And in these circumstances it is not just the debt itself that is the issue. Prolonged financial pressure can cause excessive levels of stress, which in turn can have a knock-on effect on people’s health, productivity and earning capacity.

Balancing long and short-term needs

So what can we do to help people avoid these damaging situations, and protect their overall financial health? Access to some emergency liquid savings could be the answer. It has previously been suggested that the defined contribution system could be opened up to allow early access to savings.

However, doing so creates the risk that large amounts of money will be taken out pre-retirement, leaving people with very little for later life. This method also attempts to treat a pension pot like a bank account, when in practice the two products should be used very differently and are designed as such.

An alternative could be to create a solution that feels like a single product to the consumer but in fact has different savings jars beneath the surface. This is the idea behind hybrid products and the sidecar model proposed by Harvard Kennedy School.

The approach would allow the pension pot to remain locked up, and invested for the long term, while giving savers access to an amount of liquid savings via a sidecar account.

Under the sidecar bonnet

In this model, total contributions through payroll would be set higher than the auto-enrolment minimum. The money would be split between a liquid sidecar account and a pension pot, with the additional contributions initially flowing into the liquid account.

When the liquid balance reaches a specified level, all contributions would roll into the pension pot. If a member takes cash out, the additional contributions would once again top up the liquid account until that threshold is reached.  

This approach has the advantage of increasing the total amount saved, preserving auto-enrolment contributions, while potentially increasing retirement savings in the long term if the threshold is reached.

But, relative to simply contributing more to a pension straight away, it has the attraction of keeping those new contributions accessible by creating an emergency buffer, helping to build short-term resilience.

Could the sidecar model improve people’s overall financial health? It certainly has the potential to do so. But there remain a number of questions about how it might work in practice, and our research trial next year will aim to provide those answers.

Will Sandbrook is executive director of Nest Insight