However, most individuals have made low contributions with less than half of private sector employees who saved into a workplace pension contributing more than eight per cent of their earnings.
A fifth have not saved in a workplace pension so they miss out on their employer’s pension contribution. Low asset returns and increases in life expectancy have made it harder to attain a good standard of living in retirement.
Research undertaken as part of the ‘Pensions Review’, led by the IFS in partnership with the abrdn Financial Fairness Trust, has set out the scale of the problem and made concrete policy suggestions in response.
The review has found that approximately 30-to-40 per cent of private sector employees (five to seven million people) saving in defined contribution pension schemes are on course to have individual incomes that fall short of standard benchmarks in retirement. However, prospects look better when accounting for partners’ pensions and potential future inheritances.
Mubin Haq, chief executive of the abrdn Financial Fairness Trust, said, “Auto-enrolment has been a huge success, significantly increasing the numbers saving into a pension. However, there’s much more it could achieve, especially for low earners who are currently missing out from an employer paying into their pension pot.
“Guaranteeing three per cent from the employer regardless of whether an employee makes a contribution could boost employer pension contributions by £4bn per year. This would particularly benefit women, those working part-time, young adults and the low-paid.”
Changes to the system
According to the review, a set of changes to the automatic enrolment system are needed. It has been proposed that increasing the minimum pension contributions to 12 per cent of earnings for all would boost retirement incomes. However, the IFS has said a targeted approach, that helps employees to save more at points in their lives when they might be more able to do so, is preferable.
The IFS has suggested that:
- There is a strong case for employees to receive an employer pension contribution of at least three per cent of total pay, irrespective of whether they contribute themselves. This would benefit the 22 per cent of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to their earnings being too low.
- The age range targeted by automatic enrolment should be changed from 22 to state pension age (16–74), to help even more people in paid work save for later life.
- Increased default employee contributions should be targeted at people on average incomes and above. The current automatic enrolment default minimum contributions are eight per cent of.
- The upper limit on qualifying earnings, which has been frozen at £50,270 since 2021-22, to be raised (at least for minimum employee contributions.) This limit has made it harder for people to make good saving decisions, and the real value of this limit has fallen significantly in recent years.
- Future-proof the system, by indexing key parameters in the automatic enrolment system to average earnings growth. The ‘earnings trigger’ (above which people must be automatically enrolled) is 13 per cent below the annual value of a full state pension (£11,502). On its introduction in 2012 it was 45 per cent higher than the then annual value of a full basic state pension.
In addition, the IFS has said that a set of reforms could be brought in to limit affordability concerns resulting from higher pension contributions:
- Employees who face higher default pension contributions under their suggestions should be given the choice to ‘opt down’ to the minimum pension contribution rates currently in operation.
- If the government implements legislation passed in 2023 which would increase default contributions by basing them on earnings from the ‘first pound’, it should give serious consideration to diverting the additional contributions initially into a liquid savings account. This would help those with low (or no) liquid wealth for whom ‘rainy day’ saving may be more appropriate than pension saving.
According to the research institute, implementing these suggestions would boost retirement incomes by between 12 and 16 per cent (£1,400 to £2,100 per year) for those currently on track for low and middle incomes in retirement.
However, it would only reduce the take-home pay of lower earners by a small amount (likely a less than oner per cent fall in take-home pay). In comparison, moving to minimum 12 per cent contributions would boost retirement incomes but would generate bigger falls in take-home pay for low-paid workers.
David Sturrock, a senior research economist at IFS and an author of the report, said, “It is really important to take seriously the affordability of asking for bigger pension contributions from many low-earning individuals, as well as the need for many to save more.
“We suggest a way forward that would focus the encouragement of higher contributions on periods of life when people have average, or higher, earnings. Allowing people to opt down to lower contributions, or diverting some contributions into savings accounts, are also good options.
“There is a strong case for almost all employees to receive an employer pension contribution, irrespective of whether they make a contribution themselves. That would be a bigger change to the system – and one that would likely be of particular benefit to many low earners.”