News Analysis: The government should continue to phase up minimum auto-enrolment contributions beyond 2018 to hit an aggregate 16 per cent, actuaries have said, as part of a longer-term roadmap to build on the policy’s success.
The current timetable for auto-enrolment contributions will take employers and employees from the minimum of 1 per cent each up to 3 per cent and 4 per cent, respectively, by 2018.
However, research from the Association of Consulting Actuaries, published this week, said contributions should increase by 1 per cent every two years after 2020, up to 16 per cent, in order to generate an adequate retirement income.
A person on average earnings is likely to fall markedly short of the Pension Commission’s targeted replacement income of two-thirds of pre-retirement income. Indeed, a contribution rate of between 14 and 16 per cent would probably be needed to reach this benchmark
ACA
The ACA study reflects a wider energy in the pensions industry to tackle getting an increasingly defined contribution-dependent society to engage with retirement saving.
The Pensions Policy Institute last week published a study illustrating the tension between getting DC members to save more while not encouragingopt-outs. And the government is due to report back on its ‘Strengthening the incentive to save’ consultation, which included proposals to adjust the tax relief structure to raise engagement with pensions.
The ACA’s survey of 477 employers found that four in 10 respondents were willing to see minimum contributions rise in 2020, to 4 per cent from employers and 5 per cent from employees, or higher. However the majority wanted the minima to stay at 2018 levels.
Should minimum levels go up from 2020?…
The association said even if participation remains steady as contributions are phased up, the current 8 per cent floor is unlikely to generate a comfortable retirement income.
The report said: “Assuming 40 years of contributions at 8 per cent, with 3 per cent real return on investment, a person on average earnings is likely to fall markedly short of the Pension Commission’s targeted replacement income of two-thirds of pre-retirement income.
“Indeed, a contribution rate of between 14 and 16 per cent would probably be needed to reach this benchmark.”
Tax relief as an incentive
The government’s now-closed consultation on tax relief elicited a range of ideas from across the industry on how to incentivise saving, which included sticking with the current exempt-exempt-taxed system or flipping this to a TEE structure, as well as recommendations for a flat rate.
However, consultancy Redington has proposed an ‘exempt-exempt-exempt system’, to build on the success of auto-enrolment and to create a tax-free worker’s pension.
This includes raising the aggregate auto-enrolment contribution rate from 8 per cent in 2018 to 10 per cent shortly thereafter, ideally up to 15 per cent, in line with the ACA’s recommendations.
Aiming to achieve a positive outcome for the majority of UK savers, Redington targeted its proposals at earners below the 90th percentile, focusing the pension system and tax changes to benefit those earning £50k a year or less.
Patrick O’Sullivan, director in Redington’s investment consulting team, acknowledged that any ‘give’ on tax required a ‘take’ from somewhere else.
“In any kind of change to the system there are winners and losers… it would be a net gain for the government, net gain for people earning under [£50,000] a year and a net negative for people earning over [£50,000] who are trying to save,” said O’Sullivan.
Gareth Connolly, chair of the Institute and Faculty of Actuaries’ pensions board, agreed current contribution levels are unlikely to deliver a decent pension for most individuals.
However, Connolly identified a number of potential issues that could arise with a move to a tax-exempt system.
“Any system that includes the retirement proceeds being tax-free increases the potential for individuals to run out of money more quickly. It also sets the retirement proceeds out of line with the tax treatment of the state pension,” said Connolly.
Neil Latham, principal at consultancy Punter Southall, said the industry should welcome anything that helps increase and maintain participation in long-term savings.
He suggested that a tune-up of the current system, along with a move to a flat rate of tax relief, could incentivise savings.
“Don’t break the current system, it is working and tax relief is well entrenched,” Latham said. “Tune the tax breaks, don’t scrap them.”
