How bright is the future for AE – the DC Debate part 1

The new pensions minister is considering how to increase the amount people save through auto-enrolment. What is your advice?

Andrew Cheseldine: Most commentators agree that, even when we reach the 8 per cent contribution target in April 2019, that rate may not be enough to ensure sufficient income in retirement for most auto-enrolled DC members.

There are three key reasons for this: first, the £5,824 offset from total earnings in calculating qualifying earnings (the 8 per cent equates to more like 6 per cent of average total earnings).

Second, many workers will not have a consistent working life of 40-plus years, as a result of unemployment, illness or carer leave.

Third, for most people, 8 per cent is not enough anyway.

The problem is that, of the stakeholders involved, none believe they can afford more: The government already spends a lot on tax relief; employers face accelerating staff costs via the national living wage; and employees face uncertain earnings prospects and student debt repayments.

All we can do is introduce a gradual increase over a number of years, which will have a correspondingly slow effect but is likely to be much less painful.

Changes to the definition of 'qualifying earnings' could increase monetary amounts being paid without having to increase headline contribution rates so much

Paul Macro, Isinglass Consulting

Paul Macro: We have already seen many more people saving into pensions as a result of auto-enrolment – but this process has not finished yet and the priority must be to ensure the phasing of employers is completed before doing anything about contribution levels.

However, everyone recognises that current planned contribution levels are not sufficient and need to increase.

Personally I would implement a continued programme of ‘save more for tomorrow’ by increasing the minimum contribution levels each year, but by small incremental steps, for example 0.5 per cent a year from 2020.

How high should these rates go? A total of about 15 per cent could likely tick appropriate actuarial boxes, but politically this may be too far – maybe 10 per cent to 12 per cent is more realistic.

Alistair Byrne: Automatic escalation of contributions over a period of time – what Richard H. Thaler and Shlomo Benartzi have called 'Save More Tomorrow' – can be a very powerful way to help people save.

The member’s commitment is made in advance, and each year only a modest increase is made to their savings rate, but over time the cumulative effect can be substantial.

There is also an important debate to be had about what the target savings rates should be – for some lower earners it may not make sense to save much more than the planned auto-enrolment rate of 8 per cent from 2019, given the role the state pension will play in their retirement income.

John Wilson: To date, auto-enrolment has been successful in getting people to save, but we now need to keep nudging people in the right direction by using techniques such as auto-escalation to encourage saving for tomorrow.

However, it is not just about pension saving. The lifetime Isa, which will be introduced from next year, should be more aligned with the needs of employees at different stages of their career.

This could in turn make employees more engaged with workplace savings and encourage additional saving, particularly where they are supported with an element of financial education.

Those who can afford to save into both a pension and Lisa will benefit from a very effective and versatile long-term savings strategy that could help them to buy a home, pay down/off debt, and provide a more flexible income in retirement.

This could be a very compelling proposition for employer and employee alike.

Steven Charlton: You either mandate that they save more or else you make saving into a pension the obvious thing to do with any excess disposable income.

Setting a compulsory contribution rate for auto-enrolment is a double-edged sword. For some the thought of paying more personally (as opposed to the employer paying more) may actually mean higher opt-out rates. So you end up with some paying more, but others not saving at all.

Making pensions the obvious savings option might be just as hard for government. For now, that probably means doing nothing – we need to build confidence and stability in the current system.

However, government and the Treasury seem unable to resist tinkering with it. One option to explore is simplifying the system. For example, removing lifetime allowances and the complex calculation for annual allowance.

Neil McPherson: Auto-enrolment needs to be an investment route to a decent pension in retirement fuelled by adequate contributions and investment returns.

The only effective way to ensure contributions are increased is to set mandatory levels of contribution, for both employer and employee.

Such a move would also have the welcome knock-on effect of improving outcomes. It works in other countries – notably Australia, Hong Kong, New Zealand, much of Latin America, eastern Europe and Scandinavia – but the political flak here would deter even the most determined, far-sighted minister.

Unfortunately, fortitude and staying power have not exactly been defining characteristics of our pensions ministers in recent years (with a few notable exceptions), particularly in the face of wave after wave of Treasury assaults undermining long-term pension strategy.

Ian McQuade: The priority at the moment should be to deliver the first phase of auto-enrolment. There is plenty to do just to reach that minimum level.

There will need to be another phase, increasing minimum contributions, but my view is that those increases should be introduced as a ‘save more tomorrow’ initiative with only the employee being able to opt out of increases.

There will be some employees for whom additional contributions are just not affordable, but if linked to increases in pay the net impact may be more manageable.

However, with the economy in its current state, I suspect that any changes to auto-enrolment contribution levels will be kicked into the long grass and left to the next parliament to decide.

Small and micro businesses need much more intervention to comply with auto-enrolment. Has the Department for Work and Pensions bitten off more than the Pensions Regulator can chew?

Cheseldine: The regulator and, to a certain extent, Nest, are stuck between a rock and a hard place. They can both only apply rules that government and the Department for Work and Pensions have set them. Both will be held accountable for failings that are not their responsibility.

Some small employers will simply ignore the regulations and some will comply, but without paying enough attention to their ongoing responsibilities to pay correctly calculated contributions on time.

Over time, I expect regulators’ attitudes to harden and fines to increase until most employers think of auto-enrolment as a responsibility that must be complied with – along with tax and national insurance.

Macro: Quite possibly, but we need to remember that this is new for most employers, and anything new will always take time to be accepted as the new normal.

Perhaps appropriate pension reporting and declarations could be made on companies’ tax returns, and a targeted campaign aimed at accountants and book-keepers could help as well. Either way, Workie [the government’s workplace pensions ‘mascot’] should be retired.

Byrne: Automatic enrolment for micro employers was always going to be a challenge, but it seems to be proceeding well. The key thing is making sure the advisers that small companies rely on – accountants and payroll providers – are well placed to help.

Some enforcement action may be required to make clear that the law is in place and needs to be upheld.

Wilson: Compliance rates to date have been high and auto-enrolment has succeeded in significantly increasing pension scheme membership.

By the end of March 2016, a total of 110,103 employers had been through the whole process, including 59,985 small and micro employers.

The regulator has been exercising its powers to ensure small and micro employers do not slip through the net in their failure to prepare for their staging dates.

To encourage companies to comply with auto-enrolment and support their employees in saving for retirement, the regulator needs to continue with its awareness campaign supported by the DWP and Workie.

The case for exempting the smallest employers has not been made.

Charlton: It was always going to be harder for small and micro businesses to see their way through the process of auto-enrolment and therefore more of a burden for the regulator.

Large employers tend to have queues of advisers willing to help with any process or new legislation, pensions or otherwise. But this is not the case with smaller companies, which either do not have the resources or desire to have outside influencers. They are often overlooked by the adviser community.

I suspect that by the time the process has concluded in 2018, the regulator will not only breathe a sigh of relief, but will also look back and say – given the sheer quantity of employers they have had to regulate – that they did not do a bad job.

McPherson: If the DWP does not provide the regulator with adequate resources, this crucial stage of the auto-enrolment strategy will certainly be a challenge. It should not be a surprise though – it was always known that enrolling the multitude of small and micro businesses would be the tricky bit.

What was not known was that the landscape would change so much from when the timetable was drawn up – with the political and economic landscape buffeted by uncertainty, low growth and low rates and the pensions landscape facing numerous and spreading conflagrations that the regulator is having to deal with.

The revolving door at the DWP and on the shadow benches does not help matters either.

McQuade: It probably has bitten off a bit much, but that does not make it wrong. For the very smallest businesses, the focus of the owner is on the day-to-day running of the business, 

rather than the complying with what they may consider as red tape.

Auto-enrolment is just another example of something that business owners need to know about and take action. There is bound to be an increase in non-compliance from the very low rates experienced in the first few years of auto-enrolment, and that will put pressure on the regulator.

But the regulator has an established process and seems to be identifying and taking action against companies that it knows are in breach of the regulations.

A few higher profile cases hitting the news will also help to alert other business owners to their obligations, and maybe Workie will make a difference as well, although it sounds like few people remember what it is advertising.

Should Nest be allowed to enter the decumulation market?

Cheseldine: Nest should be permitted to offer post-retirement benefit structures. In many cases they will be in the best position to do so – although it is unlikely to be for some time, as typical fund values at retirement will be below £10,000 for a while yet.

The implications are far-reaching – it implies allowing transfers-in and changes to Nest’s charging structure, because the 1.8 per cent charge would be unsupportable.

The providers may bleat about unfair competition and subsidy. They should be ignored, particularly given the forecast Darwinian consolidation of the mastertrust market

Neil McPherson, Capital Cranfield Trustees

It would also be a competitor to commercial providers. Should they be protected from such competition? My view is no, but we would need to understand all the implications before agreeing an expansion of services.

Macro: This is going to happen to an extent by default, as Nest will need something available for decumulation for its existing members and can accept transfers-in from next year.

The question will be whether it can accept transfers for decumulation for individuals who have not been in Nest for contribution purposes.

Even then, in the short-term this is likely to be a non-issue from a competition perspective, as most people looking to access funds in a ‘cheap’ way will want them out as cash in just a few payments, which is not that attractive to the other providers.

Byrne: The majority of DC scheme members keen to take advantage of the pension freedoms would benefit from a more institutional approach to decumulation. This will let them continue to enjoy the high levels of governance, lower costs and straightforward choices they have enjoyed in the workplace.

It would seem appropriate that Nest members who have saved within the scheme are also able to enjoy a full range of options when it comes to accessing their savings. Nest may also have a role to play in the wider decumulation market alongside other large-scale mastertrusts, provided it is done on a level playing field.

Wilson: We have to remember the rationale for Nest and its public service obligation, which is to help employers meet their auto-enrolment obligations where they may not be offered terms from commercial providers.

Nest is already receiving substantial support from the taxpayer in the form of the loans it has received. It is therefore quite legitimate for the pension industry to question whether an extension of the role of Nest is needed and would be fair to existing pension providers.

Early indicators show providers are responding to the new pension freedoms, and products that were previously the preserve of the wealthy are becoming more attractive to the mass market. So the consultation is arguably premature.

Charlton: Mastertrust members need to be served in the way the trustees of those schemes think is best.

If the trustees feel the needs of those members can be better met by the scheme rather than another provider then they should be allowed to offer the services that meet that need. If that involves retirement options, it should be allowed.

This should not be controversial. But what seems to be is that mastertrusts might offer products to non-members.

Nest, or any other mastertrust, should be treated the same way when it promotes its services. Competitive forces should be allowed to do their work and clients will vote with their feet.

McPherson: Why not? Nest is a strategically important player in UK pension provision, and decumulation offerings are now integral to services available.

The gold rush of mastertrust providers seeking to develop and promote their decumulation wares provides a pretty clear indication of the perceived importance to investors (and potential profit to providers).

Providers may bleat about unfair competition and subsidy. They should be ignored, particularly given the forecast Darwinian consolidation of the mastertrust market.

McQuade: Should an organisation that has received funding and support from the government be allowed to compete with commercial businesses? Does it have an unfair advantage?

Having said that, there is a real need for the industry to create innovative member-focused solutions, and if Nest joining the market can help accelerate that development, it is likely to be a positive move.

The main impact of Nest joining this market will be that the solutions developed will be more suitable for the wider market, rather than being focused on high net worth clients. Nest’s solution is likely to bring something different to the market. That will be a good thing, and Nest has a good track record of thinking differently.

Click here to read part two