Fidelity Benefits Consulting will expand on their recent work around auto enrolment and will take an in-depth look at whether what we have in the UK is sustainable for pensions schemes or if the parameters need to be different. This will draw on Fidelity’s international expertise and consider the systems in place in other countries, and their effectiveness.
The rates of mandatory contributions, under the UK’s auto enrolment regulations, are scheduled to increase in April to 5% of Qualifying Earnings, with a further increase to 8% scheduled for 2019. This change, paired with the recently announced extension of the provisions to all those over age 18 being introduced in 2020, raises the question: are these provisions likely to be enough to materially improve retirement outcomes?
The changes to date are certainly beginning to drive increases in the rates of retirement contribution being made by the working population. The question is whether this will be sufficient to enable retirees to have a comfortable standard of living.
What is a sustainable standard of living?
Typically, to maintain a standard of living in retirement, individuals would need to replicate a significant proportion of the income they were receiving prior to retirement. Whilst that may be understood, the amount of capital required to provide for a guaranteed retirement income is significantly higher than individuals appreciate.
For example, to replace an annual income of £26,520 (equivalent to National Average Earnings¹) at age 67 would require a pension pot of close to £500,000, based on current annuity rates². If we assumed the individual has a full State Pension at retirement of £8,297 per year this would imply the required pension pot would decrease to approximately £340,000.
These required pension balances contrast to an auto enrolment annual savings rate of £1,652 (assuming the full 8% contribution). Although individuals may have different income needs in retirement, it is clear that contributions made only at the mandatory rate are extremely unlikely to provide for a sustainable standard of living in retirement. So it would appear that the UK needs to do more.
Are there learnings from other countries with mandatory retirement plans?
Increasingly, countries across the globe are introducing mandatory retirement plans. Amongst the consistent design features, it is common to start contributions at a minimal rate increasing to more adequate rates over a number of years. This enables the population and companies to plan and budget for the required contributions.
Typically, to maintain a standard of living in retirement, individuals would need to replicate a significant proportion of the income they were receiving prior to retirement.
The table below shows the key contribution features for a number of representative countries:
From those countries which started plans more than 10 years ago (Australia and Israel), we have seen the contribution rates increase significantly – from rates which were similar to the initial rate in the UK, to combined contributions close to 12%. Although there is discussion in the UK about the need to increase rates of contributions (a view which would seem to be substantiated), the UK government has taken the first step to start meaningful contributions and has provided a platform for further increases.
There is one aspect of the UK design which does diverge from international practice and that is the option to opt-out. Although individuals can opt-out, since the introduction of auto enrolment in 2012 there has been an increase of 5.4million to 78% of eligible employees participating in a workplace pension in 2016³. This would indicate that the rate of opting-out is relatively low, but research shows this is more highly concentrated in:
• certain industries such as agriculture and construction
• companies with smaller employee populations
• individuals earning at or below National Average Earnings
So the issue of non-participation seems to be more prevalent amongst low paying industries or those on lower earnings levels. As an aside, it is interesting to note that there is no material difference in participation rates between males and females.
¹Based on estimates of weekly average earnings from the Office of National Statistics
²Based on indicative insurance quotes for a Single Life, non-smoker living in London with no pension increases
³From the DWP Official Statistics published on 15th June 2017