Since the government began phasing in auto-enrolment almost seven years ago, 10m people have now joined their workplace pension scheme.
By encouraging Brits of all ages to save for retirement, the auto-enrolment system was designed to stop the UK from hurtling head-first into a pensions crisis. So far, it’s been a success.
Even more people are signing up than the government predicted – the opt-out rate is around seven per cent, which is far lower than the Department for Work and Pensions’ initial prediction of 28 per cent. Auto-enrolment is an example of how policy can positively change the savings landscape of a nation.
There is no criticising the scheme’s good intentions. Some, however, have raised concerns about affordability.
The government has stepped up the minimum contribution rate over the years, and from 6 April, it will implement its final hike to eight per cent, of which employees will have to contribute five per cent of their monthly salary. This is a marked jump from the current five per cent, of which employees have to pay three per cent, and employers two per cent.
It’s a sudden increase that could shave hundreds of pounds off the amount people take home each year. And the worry is that, despite this money being allocated to employee’s long-term savings, the rise could prompt more people – particularly those on lower incomes who are already cash-poor – to opt out.
“This isn’t the first hike in contribution rates, but it will be the hardest,” warns Ian Browne, pensions expert at Quilter, pointing out that markets are increasingly volatile, meaning that some people will be questioning why their pension pots are worth less than they put in.
“Combine that with the nervousness around Brexit, and you’ve got ingredients for the policy’s downfall.”
It is, of course, important not to be blinded by short-term market struggles, and Browne stresses that, with more people investing today, fewer risk living in poverty later in life. “We need to hammer home that foregoing yet more of your salary is not only worth it, but is necessary.”
By making pension saving the default option, auto-enrolment relies on people’s inertia. The good news is that the consensus among most experts is that this will continue to be the case, even when the higher contribution rate comes into force.
“So long as people don’t have to make difficult decisions around the complex subject of retirement provision, they are likely to stick to the status quo,” says Bob Scott, senior partner at LCP.
It is also thought that the new rate won’t hit people as hard as they might expect. A recent report from Royal London concluded that the impact of these extra contributions will be minimal, because they will be partly offset by a more generous income tax system.
“This, together with annual pay rises, is expected to cushion the impact of contribution increases,” the report reads.
Interestingly, Royal London estimates that take-home pay could actually increase once all of these factors are taken into account.
For example, a worker who earns £20,000 a year and gets a pay rise in April 2019 in line with the growth in average earnings (3.2 per cent) would get an extra £244 per year in take-home pay, or around 1.5 per cent, even though they’re paying five per cent of their salary into a pension, rather than the three per cent.
Also bear in mind that, even when the government increased the contribution rate last April, opt-out rates only rose marginally by 0.4 per cent between the first and second quarter of 2018, according to Royal London.
Let’s hope that opt-out rates will remain low after the next rake hike – because if workers stick with the scheme, they’ll realise that it’s worth it.
“For a minimal impact on take-home pay today, the long-term savings benefits are an excellent trade-off,” says Scott.
In fact, he says that people who are minded to opt out of their employer’s scheme need to understand the value of the “free money” they’d be giving away as a result. “Nobody would turn down a pay rise and, providing it’s affordable, they shouldn’t say no to their company contributing more into their long-term savings.”
While April’s contribution increase might seem significant on the face of it, it’s only a starting point, because people need to save closer to 16 per cent of their salary to secure a comfortable retirement.
So really, auto-enrolment is just the beginning. We’ve got further to go to encourage a whole generation to save.
There are also ways that the system could improve.
Indeed, Ben Stanway from Moneybox warns that it has unintended consequences. For one, whenever you switch jobs, you’re often given a new pension provider. “With the average person now having 11 jobs over the course of their career, it becomes difficult to keep track of all your old pension pots,” he says.
While a pensions dashboard will go some way to helping people get to grips with their pensions, Stanways suggests that employees should also have the right to choose their pension provider, as they do in Australia.
“As well as giving people the power to combine all their pension savings into one place, this would introduce some much-needed competition into this old-fashioned industry. This move would put power firmly back in the hands of the consumer and give them greater control over their financial futures.”
And perhaps the UK could follow in Australia’s footsteps by making auto-enrolment compulsory, so that no one opts out.