The minimum contribution levels for auto-enrolment risk making adequate pensions as rare as winning the lottery, says the Pensions Management Institute’s Tim Middleton.
One area of particular concern is the adequacy of the currently planned contribution levels.
A commonly-cited factor behind the low opt-out rate experienced to date has been the low rate at which members contribute.
Like the lottery ticket, a weekly contribution of £1.50 is very unlikely to result in an optimal member outcome
If an employer contributes at the current statutory minimum rate, members will pay just 1 per cent of qualifying earnings. For an employee paid the national living wage for a seven-hour day and five-day week, just 57 per cent of earnings are pensionable and the resulting contribution will be about £1.50 per week.
When a member’s weekly pension contribution costs less than the price of a lottery ticket, it is hardly likely to lead to an opt-out. However, like the lottery ticket, it is very unlikely to result in an optimal member outcome.
The next two years will see the implementation of phasing. This will increase member contributions to an implied statutory minimum of 3 per cent.
There is a real danger that many employees – particularly those on medium or higher earnings – will feel the burden of pension contributions far more significantly than is currently the case and will stop saving.
Minimum contributions create false sense of security
The long-term statutory minimum contribution rates are rather dangerous. It is reasonable for a lay person to assume that a rate set by government will be adequate to secure a comfortable retirement.
However, there are few industry professionals who would regard 8 per cent of qualifying earnings as remotely good enough to support a comfortable retirement. Government needs a strategy for driving up overall contribution rates to a level that is at least double that of the current minimum.
There have been a number of suggestions for subtly and affordably increasing members’ contribution rates. A frequently cited strategy is Save More Tomorrow, which sees annual salary increments diverted to higher pension contributions. This assumes of course that annual salary increases will be awarded.
Government would also do well to avoid initiatives that compete with its own policy objectives. The lifetime Isa may or may not be a ‘Trojan Horse’ designed to prepare people for a pensions tax regime of upfront payment. However, it could tempt younger employees away from pension saving in favour of a foot on the housing ladder.
If UK employees are to enjoy a comfortable retirement, they must address the stark reality that rates of contribution need to be significantly higher than they expect to pay currently. This is not going to be a comfortable message for any government to communicate.
But allowing the public to assume that current statutory rates are adequate will have serious consequences. If we fail to take appropriate action soon, we might as well advise employees that lottery tickets are a better form of retirement planning.
Tim Middleton is technical consultant at the Pensions Management Institute
