In the second article of our series following the publication of our white paper on how to improve future retirement adequacy, we dig deeper into how contribution design and awareness are pivotal to achieving better retirement outcomes and equality of savings.
Our recent white paper, What can the U.K. do to ensure future retirement adequacy? set out three key actions to deliver better outcomes for defined contribution (DC) pension savers:
- Save more
- Maximise returns
- Make better retirement choices
In the second of our mini-series exploring the key themes of our paper, we focus on the first of these actions – saving more – and look at what is needed from contribution design to help give defined contribution (DC) pension savings the boost they need.
Contributions are critical in determining outcomes
It might sound obvious, but paying more DC pension contributions is one of, if not the biggest, lever that can be pulled to improve retirement outcomes.
The more money that is paid in, the more money will come out.
In our paper, we highlight the impact that increasing the default contribution rate from 8% to 12% might have – giving individuals a better opportunity to achieve a moderate retirement living standard (based on the Pension and Lifetime Savings Association (PLSA) retirement living standards).
How can we get more savers to that level, recognising the increase in cost that may impose?
Default employees onto at a higher level
Traditionally, for companies offering flexibility in the contributions offered through a matching contribution structure, employees are entered at the minimum contribution level (77% of companies enrol at the lowest available level—WTW 2023 DC Pension and Savings Report).
However, for many employees, the contribution level they join on is the contribution level they are likely to stay on.
This means that employees are missing out on potentially valuable additional contributions available from their employer, as well as the boost they would get from increasing their own pension contributions.
So what if this was flipped around, and employees were defaulted to the maximum contribution level? For those schemes that already do this, we see that inertia applies in the same way, with many employees staying on the higher contribution level, despite the opportunity to 'opt down' if affordability is an issue.
As well as boosting pension savings, increasing the default contribution level could also change employees' perceptions. Without appropriate messaging, employees may believe that being enrolled at the minimum contribution level will be 'enough' and don't understand the need to save more to achieve an adequate retirement income. Enrolling employees at higher levels may help them to view this as the 'minimum' for a decent retirement income and accept that dropping down below this will reduce their pension savings at retirement.
Bringing employees up to the right level
We understand that it may be a challenge to make changes to the default contribution level for all employees at once. We also understand that some employers may be concerned that they will have to pass these additional costs to customers, so becoming less competitive in their markets. For this reason, we call on policy makers to introduce the increase to minimum contribution levels so all employers can operate on a level playing field.
Introducing higher default levels for new joiners to an employer can start to address adequacy and encourage higher savings. But what about existing employees? Auto-escalation could be considered – for example increasing the level of employee pension contributions by half a percent or one percent each year, as part of their annual benefit selection or pay review. That way it's less of a jump for both employees and sponsors but responds to the need to increase pension contributions over the longer term. This could even be built into an automatic enrolment framework.
Auto-escalation can be particularly effective in boosting savings rates without overwhelming employees and employers financially."
Rudi Smith | Director
Under-pensioned groups
We see the challenges of saving enough for a comfortable retirement across the board, however there are particular groups who consistently lag behind. We've all heard of the gender pay gap, but what about the gender pension gap? A recent report published by the Pensions Equity Group notes that, on average, women retire with half the pension of men. There are many factors to this, including salary differences, lower levels of contributions and more risk averse investment options, with the consequence that women generally save less into their pensions than men. The Pensions Equity Group report sets out a number of actions that employers can take to close the gap, including the importance of good pension contribution design.
The Gender Pension Gap is far greater than the Gender Pay Gap, and harder to solve due to all the contributing factors."
Anne Jones | Director
72% of companies (WTW DC Savings Survey 2023) offer a matching contribution structure. That means the more an employee contributes, the more the Company also contributes. This can be an effective way to encourage employees to save more, as an employee is "rewarded" for contributing more and gains an additional benefit from their employer. With both the employee and employer making more contributions, this can offer a real boost to the level of DC pension savings being made.
However, while this flexibility and incentive to save is valued, it can exacerbate inequality of pension savings, with some groups within the workforce being less likely to take up the higher contribution levels on offer. We have seen evidence that defaulting at the higher level can help reduce these differences. Interrogating the plan design and how employees are engaging, helps employers identify 'at risk' groups and should be part of any plan design discussions.
Another of the factors contributing to pension inequality arises from periods of leave, meaning time out of the savings journey. Consideration of how leave policies can be adapted to prevent further exacerbating the issue, together with reviewing the support employees get when they return from leave, can help reduce this issue.
Employee understanding
There's no doubt that contribution design and higher contributions themselves play a key role in achieving adequate retirement outcomes. But there is a need for more effective communication and education too, so that employees understand the options open to them and what they are on track to achieve.
In our paper, we talk about support for individuals in making retirement choices. But we also recognise that there's a need for support and education throughout an individual's saving journey, highlighting the benefit of paying higher contributions, the tax relief they'll receive, the importance of making up any missed time, and why that has a longer-term benefit for them as they get to retirement.
We're going to explore this further in a future article.
The elephant in the room – cost
There are undoubtedly challenges that employers and individuals face with a proposal to increase spend on pensions. We know that there is likely to be some pain suffered through higher contributions, both from an employer business perspective and from an individual perspective in terms of take-home pay. The cost associated with these increases may not be as substantial as anticipated, with factors like salary sacrifice reducing National Insurance liability, and pension contributions being a means of more cost-effective remuneration. If people are unable to retire due to lack of affordability, an ageing workforce can also carry longer term cost implications for employers through higher benefit costs and absenteeism amongst other things. Our Global Benefits Attitude Survey reports 53% of employees feel they are not on track to have sufficient retirement savings, more detail on this report can be found in our press release: Majority of UK employees worried about meeting basic costs, WTW survey finds.
Collectively, we need to think ahead and consider how some short-term pain now can lead to a long-term gain for both employers and individuals in the future.
Coming next
Look out for our next article, in which we'll examine default investment strategies and how the right design can improve retirement outcomes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.