An increase in contribution levels is seen by many in the defined contribution space as necessary to ensure members have sufficient retirement income, but could there be another way to a more comfortable retirement?
The fact that initial auto-enrolment contribution levels were set at 1 per cent for employees is testament to the difficulties inherent in parting with pay, even if it is only deferred until retirement.
Yet this general reluctance to invest meaningful sums into retirement plans did not stop the Independent Review of Retirement Income arguing that total pension contribution rates should be 15 per cent.
Formed by the Labour party two years ago, and chaired by David Blake, director of the Pensions Institute at Cass Business School, the IRRI reported back this March stating: “An adequate pension needs adequate contributions. To have an adequate pension in retirement, Middle Britain needs to understand that – together with the employer – it has to save 15 per cent of its lifetime earnings in a pension scheme.”
To have an adequate pension in retirement, Middle Britain needs to understand that it has to save 15 per cent of its lifetime earnings in a pension scheme
The Independent Review of Retirement Income
And the IRRI is not the first body to reach this conclusion. A year earlier, pensions consultancy Redington released its ‘Age of Responsibility’ report, which also called for a national contribution target of 15 per cent.
Redington says average contributions to DC schemes are between 5 per cent and 6 per cent of earnings; a significant under-save of 10 per cent. And by 2018-19 auto-enrolment minimum contributions will reach 8 per cent; far short of a double-figure target.
Robert Gardner, founder and lead investment consultant at Redington, says: “The UK is facing a demographic abyss and retirement crisis unless we act fast to meet the wide-ranging implications of this dramatic shift in responsibility… Savers should be saving at least 15 per cent of their salary in order to sustain a comfortable retirement.”
Yet some trustees feel that forcing contribution targets as high as 15 per cent will prove counterproductive.
Chris Roberts, trustee at professional trustee company Dalriada, says current opt-out rates for auto-enrolment are low because members are paying minimal contributions, and any efforts to increase members’ payments more dramatically could drive people away from pension saving.
He says: “While driving mandatory contributions up to such a high [15 per cent] level might be good, we need to strike a balance between getting people to save more and getting them to save at all.”
Retirement needs
Roberts says the 15 per cent target is somewhat arbitrary since it will only be suitable for some savers and is dependent on their stage in life and retirement income goals.
He suggests the focus should switch from how much members pay into the scheme, to how much they need in retirement.
Roberts says: “Fifteen percent [contribution rates] might be fine for one member, but it might be 10 per cent for another and 30 per cent for another. It depends on how much money you need in retirement and what your wealth looks like.”
While a 15 per cent target may be contentious, there is little dissent from the pensions industry that there needs to be a wholesale increase in long-term saving.
However, some fund managers argue that making money work harder is just as important as increasing contributions if people are to achieve a satisfactory retirement income.
David Hutchins, head of pension strategies at asset manager AB, says: “The onus should lie predominantly with the pension providers, who are responsible for ensuring that individuals need to save no more than is necessary. These providers must do everything in their power to deliver the best expected investment returns, net of fees.”
Striking an investment balance
The problem in relying on investments to deliver a suitable retirement income is threefold.
The majority of members are in the default fund, which is forced to cater to a wide variety of members with differing investment objectives.
Those default funds set up as part of auto-enrolment are subject to a fee cap of 75 basis points, which can restrict the use of more aggressive investment strategies.
There is a danger that using more aggressive strategies can create volatility, which acts as a disincentive to save, or they may underperform entirely.
Tackling the first point, Dalriada’s Roberts says it is becoming increasingly common for trustees to offer an alternative suite of default funds.
These still take the pressure off the individual in terms of actively managing the fund on their behalf, but with the option of being more aggressive – or indeed more risk-averse – if the member so wishes.
Getting members engaged with what they need to save is a far greater challenge [than increasing contributions] and is the one we should be concentrating on
Jo Sharples, Aon Hewitt
Roberts says: “[For] those members who don’t want to go to self-selection but who want something more than the default, trustees might consider offering a suite of funds rather than one catch-all.”
With regard to cost constraints and volatility concerns, default strategies have evolved to blend passive and active management with the aim of achieving positive returns at an affordable price.
Jo Sharples, investment principal at consultancy Aon Hewitt, says: “[Default funds] can be sophisticated and clever now. You can do much more with passive management and still use good active managers more sparingly. Trustees have to think about their total fee budget and where they spend it.”
The default fund requires continual evolution if it is to achieve good outcomes for members, but there is also a need for improved financial education for individuals if they are to engage with their DC pension.
She says: “Getting members engaged with what they need to save is to me a far greater challenge [than increasing contributions] and is the one we should be concentrating on.”
Target contribution rates can help focus attention on where members are falling short, but without the context of a savings objective, concentrating on one level may be counterproductive.
Paying enough money in is critical, but it is only one of a number of moving parts, all of which need requisite attention.
Gill Wadsworth is a freelance journalist
