Straightforward policy successes are a rare achievement in government and need celebrating when they arrive, lest we forget that policy matters. The recent sizeable gains the UK has made on private pension saving as a result of the introduction of auto-enrolment are therefore a clear cause for cheer. But challenges remain, starting with the increase in the minimum contribution rate that comes into force from today. Ensuring that auto-enrolment genuinely improves outcomes in retirement in the decades to come means finishing the job of implementation – supporting the policy through its next phase.
The notion of auto-enrolment – whereby employees are placed into a workplace pension scheme by default, with the ability to opt-out if they wish – was spawned by the Pensions Commission back in 2005, and quickly gained cross-party support. Roll-out started in 2012, with larger firms the first to be required to introduce the scheme. Since February 2018, all employers have been obliged to enrol any employee earning more than £10,000 a year.
In terms of coverage, the impact has been very significant. As the chart below shows, overall workplace pension coverage among employees has jumped from a low of 46.5 per cent in 2012 to a new high of 72.9 per cent in 2017. And this increase has come about even as the proportion of employees holding defined benefit pensions has continued its longer-term decline – highlighting the importance of the auto-enrolment policy in improving private pension coverage. Altogether, the number of employees auto-enrolled hit 9.4 million in February 2018, broadly in line with the government’s initial target of “up to 10 million”. Furthermore the biggest gains have been among the lowest paid: the number of people earning less than £300 per week with a defined contribution pension has risen four-fold since the policy was introduced, compared to a doubling for those earning above this amount.
However, while auto-enrolment has had a very clear and positive impact on coverage, typical employee contribution rates are often low, so very few people have opted out so far. This reflects the minimum contribution rates stipulated under the policy. Until today, auto-enrolment has brought with it a minimum default contribution of 2 per cent of qualifying earnings (£5,876 to £45,000 in 2017-18, rising to £6,032 to £46,350 for the new financial year). At least 1 per cent of this total has had to come from the employer, with the employee making up any shortfall. As the next chart shows, this arrangement has resulted in a large share of employees contributing relatively little to their workplace pension as of April 2017. In the private sector – where auto-enrolment into defined contribution schemes has been most common – more than half of all employees with a workplace pension contributed less than 2 per cent of their qualifying earnings.
From today, the minimum contribution is rising to 5 per cent (with at least 2 per cent from the employer). And the minimum will rise to 8 per cent next April (with at least 3 per cent from the employer). Today up to 6.9 million employees could be affected because they had previously been contributing less than 3 per cent, though some of these may be people who have opted out of their workplace pension scheme. Some also may be contributing close to the required amount already but 6 million were contributing less than 2 per cent. The majority are in their 20s and 30s, and half work in lower-paid sectors such as retail, care and social work. The implication is that employee contributions will need to jump significantly from where they have been to date, and that the increases are likely to disproportionately affect the lower-paid. While that’s good news for the longer-term savings profiles of individuals, it will have an inevitable livings standards impact in the near-term too.
Clearly there is a risk that these increases will cause employees to take greater notice of the immediate pay packet trade-offs of saving for a pension, and so opt-out. That risk is heightened by the weak real-terms wage growth anticipated over the next two years – especially coming after what has already been a terrible decade for pay. By way of illustration, we model below the potential effect of increasing employee contributions on the take home pay of a median-earning full-time employee. It highlights the very significant drag on take-home pay this will constitute, with a lifting of employee contributions from 1 per cent to 5 per cent equating to a ‘lost’ £940 a year by 2019-20.
Resolution Foundation modelling for the Intergenerational Commission has shown that the pensions reforms of recent years – including auto-enrolment – have the potential to support retirement incomes for today’s younger cohorts that broadly match those of today’s pensioners. But such an outcome depends on changing the picture on contribution rates without increasing opt-outs that would lower coverage. Therefore in raising the contribution rate the government needs to keep in mind the increased costs and risks that savers – particularly the young and those on low-pay – are being asked to bear. As well as boosting take-home pay through policies such as the National Living Wage, the government should monitor opt-out rates, consider what can be done to mitigate the impact on earnings as contribution rates rise, and support and de-risk pension saving, particularly for those on lower-earnings.
We will explore these, and other related issues in the final report of our Intergenerational Commission, but in the meantime, though it’s worth cheering a policy success, we recognise that even in the case of auto-enrolment little success comes automatically.