Cost of living crisis makes AE expansion unwise

Inflation, and the rising price of food, fuel and other essentials, has led to a fall in living standards not seen since the 1950s, according to forecasts from the Office for Budget Responsibility in March.

The pensions industry remains keen for the government to implement proposals arising from the 2017 AE review, which would lower the age threshold from 22 to 18 and start savings from the first pound of earnings, while many, includingthe Association of British Insurers, have also championed an increase in the minimum contribution to 12 per cent.

However, modelling from Hargreaves Lansdown, in partnership with Oxford Economics, suggests the costs of implementing these reforms in the current economic climate would be significant, and the poorest would be subject to a further squeeze on their income and living standards.

People on lower incomes are particularly affected as are younger people who may find they can build bigger pensions but struggle to get on the housing ladder. We think a more nuanced approach needs to be taken

Helen Morrissey, Hargreaves Lansdown

Now is not the time

Hargreaves Lansdown included the findings from its Savings and Resilience Barometer in its report published on July 11, which argued that the timetable for AE expansion should be set back until the cost of living crisis has abated.

The research acknowledged the potential benefits of raising the AE minimum rate to 12 per cent, which could add 9.3 per cent to the adequacy of the nation’s pension savings — more than double the 3.4 per cent increase reaped by AE expansion.

However, it warned that focusing on these benefits in the short term does not take account of the significant trade-offs they entail, especially with regards to household resilience.

When analysing the impact of AE expansion, the report projected that surplus income would fall instantly by 3 per cent in the AE expansion scenario. “This would, in turn, feed into a 3.3 per cent fall in rainy-day savings adequacy (this is measured as holding three months’ essential expenditure as cash) and 3.3 per cent fall in our net financial assets measure by 2029”.

The impact of raising the minimum rate to 12 per cent would be “even more stark”, it continued, with an immediate 8.8 per cent decrease in households’ surplus income, followed by “a knock-on fall in emergency savings adequacy of 9.8 per cent by 2029, and a fall of 9 per cent in our net financial assets measure”.

Without considering trade-offs, lower-income households would benefit most from the reforms, “[improving] their pension value by 15.5 per cent compared with 3.5 per cent for everyone under AE expansion, [...] and 27.8 per cent compared with 9.3 per cent under an increase to 12 per cent contributions”, the report explained.

However, when trade-offs are considered the impact is significant, leading to a “22.2 per cent [fall in surplus income] upon implementation in 2025”. 

“This leads to a fall of 8.7 per cent in liquid asset resilience and a 4 per cent fall in net financial assets by 2029 for the automatic enrolment expansion scenario. The decline in short-term resilience across these three indicators is even higher in the 12 per cent contribution scenario,” it stated.

A similar effect is evidenced when looking at the impact between age groups. Millennial and Generation Z households “see an improvement in their pension value of 5.7 per cent compared with 3.5 per cent for the nation overall under AE expansion, [...] and 14.5 per cent compared with 9.3 per cent under an increase to 12 per cent”, the report explained.

However, this has a significant trade-off, impacting all indicators of short-term resilience, but particularly potential house-buying, as the overall fall in net financial assets makes it even more difficult to save for a deposit.

Don’t be hasty

Rather than rushing into the reforms now, while the cost of living crisis is acute, Hargreaves Lansdown recommends a more cautious approach to timetabling, setting the most consequential reforms back until the crisis has abated.

It argued that this means the reforms should not be implemented before 2025.

Rather than making mandatory increases to minimum contributions, it suggested that the government should encourage people to increase their contributions voluntarily as and when they are able.

“The potential to pay more into a pension and get a matching contribution from the employer could be an attractive incentive,” Hargreaves Lansdown said.

“Previous [...] analysis shows as many as six in 10 people could be encouraged to boost their contribution if such an arrangement were available, so we would welcome a further study to see the potential impact of these arrangements.”

“Such arrangements could be popular as people only increase contributions as they need to, and employer contribution increases are targeted towards those who value them.”

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said: “Boosting pension saving is hugely important but cannot be tackled in a vacuum. Unless changes are timed carefully, we risk placing demands on people to save for tomorrow that risk undermining their financial position today. 

“If people are struggling with their day-to-day costs, then we risk any further boost in pension saving leading to people saving less and even building up debt.”

Morrissey acknowledged that reforming and expanding AE could potentially be of benefit, but reiterated that it should not proceed without regard to the challenges people are facing today.

“People on lower incomes are particularly affected, as are younger people who may find they can build bigger pensions but struggle to get on the housing ladder — we think a more nuanced approach needs to be taken,” she said.

Lang Cat’s director of public affairs Tom McPhail welcomed the report’s nuanced take, pointing out that, “to a man with a hammer, every problem looks like a nail”.

“The pensions industry is very good at demanding the government legislate to give it more money, so it is welcome to hear a more measured voice in the debate,” he said. 

“Before demanding more money, the pensions industry also needs to do some heavy lifting on pensions taxation reform. Everyone knows this is a hugely inefficient waste of public money, but it is also complex and politically challenging. The pensions industry should be taking a lead to show how it can be achieved.”