There is considerable concern among policymakers and consumer groups that many are not saving enough to ensure a good standard of living in retirement, even after the recent success of automatic enrolment in boosting pension enrolment. Moreover, pension participation for the self-employed, as well as adequacy, remains a massive concern.
This month the Institute for Fiscal Studies launched a series of new reports investigating the drivers of pension saving among workers. On Wednesday, the Institute for Fiscal Studies (IFS) and Nuffield Foundation hosted an event where they presented their results and examined what drives differences in how much people save in their pensions, particularly in terms of their age, earnings, and tax incentives. They also discussed important differences in how these factors affect employees and the self-employed.
The main conclusion of their reports is that people’s pension saving decisions are generally inert and are therefore liable to be highly driven by default options. The importance of nudges is particularly demonstrated by the success of automatic enrolment.
IFS findings: Employees
One of the main findings of their work is that, despite strong theoretical reasons for them to be linked, changes in earnings only have a small effect on pension saving decisions. Before automatic enrolment was rolled out, a 10% increase in real earnings over five years is associated with only around a 1% increase in the probability of joining a pension among those aged 22–29, falling to an even smaller 0.2–0.6% increase in the probability of joining a pension among those aged 50–59. Changed in earnings still have a small effect on pension participation in 2019–20, except for when they lead to someone earning at least £10,000 a year and their employer therefore being required to enrol them automatically into a workplace pension.
Due to these findings, the IFS concluded that a form of ‘auto-escalation’ – that is, for default pension contribution rates to increase alongside increases in earnings – could therefore nudge people to make better pension saving decisions.
Moreover, the IFS found that there is little evidence of people changing their pension saving at any particular ‘trigger age’, and that pension saving has become even less responsive to tax incentives since the roll-out of automatic enrolment. They also found that significant events in people’s lives generally have little impact on private sector employees’ pension participation and contribution rates. However, they did find that pension contributions tend to increase by around 0.4% of pay more when people move from renting to having a mortgage, and by around 0.3% of pay less after the arrival of a first child.
These findings suggest that nudging employees to change their pension saving around major life events could have desirable effects. One example would be for mortgage providers to ask their customers in advance how much of their mortgage repayments they would like to divert into their pension when their mortgage term ends, and making it as easy as possible to achieve this.
IFS findings: Self-employed
Since the introduction of auto enrolment, the gap between pension participation rates of private sector employees and the self-employed of the same earnings has widened. The low levels of pension participation among self-employed workers mean that in order to increase the pension participation rates of self-employed workers meaningfully, new innovations on how to incorporate pension saving defaults for the self-employed as part of the tax system are needed.
The IFS found that of the self-employed who do save for a pension, nearly a quarter choose the amount to save as a monthly or annual round number in nominal pound terms, with the most common amount being £50 per month. Among those who are still saving in a pension nine years later, close to a quarter (23%) save the same amount in cash terms. The fact that the cash value of contributions is unchanged year after year implies that a form of auto-escalation could be a good way to boost their pension savings, for example using a direct debit that increased in line with inflation, or at another pre-set rate.
Tom Josephs, Director for Private Pensions Policy at the Department for Work and Pensions (DWP), responded to the findings in the IFS reports. He said the analysis and evidence is really relevant to the current policy development program at DWP. He talked about DWPs priorities for private pension policy and how they relate to the specific areas covered in the IFS work. The Minister for Pensions Laura Trott set out her policy priorities recently on 30 January. The three pillars which the Minister set out as underpinning her vision for pension reform are 1) adequacy 2) fairness and 3) predictability.
On adequacy, he thinks we have a solid foundation through the combination of the new state pensions and the success of automatic enrolment in delivering increased private pension saving but they do recognise that nevertheless many people aren’t saving enough for retirement. Their own research has shown that two in five people are still likely to be under saving for their retirement against the target rate.
He noted that one of the priorities for the Government is to deliver the recommendations of the 2017 review to expand automatic enrolment by lowering the age criteria for enrolment and removing the lower earnings limit so people start saving from the first pound of earnings. The Government just announced last week that it is supporting a Private Member’s Bill which would provide the legislative powers to deliver these reforms in the current parliamentary session.
He mentioned they do also need to be thinking about what can be done in the future and thinks the IFS analysis is interesting in particular their points on auto escalation and the potential for default options and nudging people to save more at key points in their lives. He mentioned they have already been holding focus groups to explore timely moments for pension engagement. He hopes that better technology can change this over time; the pensions dashboard will be an important new tool and they are fully committed to deliver it despite delays.
He agrees with the IFS on the challenge around the self-employed; there is clearly a huge gap in terms of private pension provision. With NEST Insights they have recently published results of trials on behavioural messaging and saving mechanisms on financial digital platforms to test the role those kind of tech based nudges and the value of flexible saving. Building on this, they are doing some with the UK trade body for business software developers to look at whether there is feasibility of building a retirement saving solution within software used by the self-employed to manage their money. They are also keen to explore hybrid saving vehicles which might combine accessible savings and long term savings which could preserve control for individuals in managing their short term finances alongside saving for retirement.
He noted they have also inserted a digital prompt to MaPS pension guidance into self-assessment tax return and they are looking using evidence from the work of HMRC and NEST Insight to build on this.
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