Pensions minister Richard Harrington has set a target for savers to achieve a £250,000 pension pot by the time they retire, but research from Aviva has shown auto-enrolment contributions would need to rise steeply.
The Department for Work and Pensions’ (DWP) next steps for auto-enrolment will mark a decisive stage in the government’s pension record.
The common view is that auto-enrolment has been a great success so far. However, the real test for the policy is in the years to come and whether it will translate into adequate retirement saving for the majority of the British public.
Current contribution levels will result in a dramatic savings gap, falling short of the pension minister’s stated target, according to research Aviva has conducted for New Model Adviser®.
If the government wants to get workplace pension savings to levels that correlate to adequate retirement for the masses, contribution levels need to rise dramatically.
How big a pension pot needs to be by the time a typical UK worker retires was indicated by pensions minister Richard Harrington (pictured), in a talk he gave to the Trades Union Congress (TUC) earlier this month.
Harrington, who came into the post last summer, said he wanted to simplify pension saving during his time in office, and wanted to use a simple premise to help form policies.
The starting premise was that the average salary in the UK is just under £27,000, according to the Office for National Statistics, and people want to retire on two-thirds of their salary.
At a basic level, Harrington said that, with the new state pension of around £8,000 per year, there was a £10,000 per year gap to make up annual retirement incomes of £18,000. To achieve this £10,000, he said savers needed retirement pots of between £200,000 and £250,000.
‘It is very clear to me that, for people starting work today, that has to be their objective,’ he said. ‘Every day I think of that figure [£200,000 to £250,000] in the morning and it is not a bad way of trying to decide policies,’ he said.
However, a £200,000 to £250,000 pot remains a distant dream under the current auto-enrolment minimum contributions.
The state of play
As it stands, minimum auto-enrolment contributions are 2% (split equally between employee and employer). By April 2019 this will rise to 8% (5% employee and 3% employer).
Research carried out by Aviva for New Model Adviser® has shown an 8% total will still leave savers woefully short of that target of a £200,000-plus figure.
As the table above shows, if savers finish their career on a salary of £27,000, having built up every 10 years from £18,000, and save for 40 years, they will have a pension pot of £73,621 at contribution levels of 8%. It assumes an annualised rate of growth of 2.5%.
If all the variables stay the same and contribution levels are increased to 12.5% the pot receives a bit of a boost but still falls well short, with a total of £115,033.
To reach Harrington’s target, an individual whose salary builds up to £27,000 over their career and saves for 40 years with no breaks would need combined employee and employer contribution levels of 25%. This would get them to a pot of just over £230,000.
This shows that contribution levels need to be sharply increased to meet the goals of the pensions minister.
Holes to plug
Dale Critchley, pensions policy manager at Aviva, said the figures showed an 8% contribution level would create savings holes in the long run.
‘Next year we’ll see the first contribution rise and in 2019 it will reach a total of 8%,’ he said. ‘When it reaches that point, those who have stayed in their workplace pension scheme will be putting a reasonable amount into their pension pot. But, as our figures show, even saving at 8% for 40 years may not be enough to bridge the income gap at retirement,’ he said.
Critchley added that because auto-enrolment was a new policy, only started in 2012, there would be savers who would have even less in their pots at retirement because they would have years when they were not saving.
‘This [data] is for people who are saving for 40 years, which means joining their workplace pension scheme in their 20s,’ he said. ‘There are many thousands of people in their 30s, 40s and 50s who have no pension savings and are just now being auto-enrolled. They will have to consider their options to achieve their target income. It could mean saving well above the minimum auto-enrolment contributions or working longer than they plan to.’
Ahead of the DWP’s auto-enrolment review, which will investigate contribution levels, Aviva made its own recommendations to the government at the end of last year. The provider said the 8% levels were ‘clearly inadequate’ and advocated pushing them up to 12.5% by 2028.
Former pensions minister Ros Altmann (pictured above) also stressed the inadequacy of the 8% level in a piece for New Model Adviser® last month. One of the options for addressing this is auto-escalation, whereby a ‘proportion of every pay rise is automatically put into extra pension contributions, unless the worker opts out’, Altmann said.
A balancing act
While it might be easy to criticise the DWP for the current low contribution levels, there are a whole range of factors the government is contending with when it sets the levels.
The first is opt-out rates, the low levels of which have caught many by surprise since the policy began. Initially the government expected opt-out levels of around 25%, but the level of those deciding to drop out of the system are around 9% according to DWP figures from 2014.
However concern that these opt-out rates will rise if contributions go up is on the pensions minister’s mind, and he has mentioned in a number of speeches that he is ‘concerned’ about the potential for people moving out of the system as minimum levels increase.
Then there is the wider economic element: if the economy faces a downturn shortly after minimum contributions are ramped up, this could also lead to vast swathes of the public opting out, undoing the good work done so far. With uncertainty facing the economy as Brexit negotiations commence, the government will be aware of the wider economic considerations to the policy.
Labour’s shadow pensions minister Alex Cunningham feels the potentials for opt-outs should be front and centre of the government’s thinking and said the DWP was right to be ‘cautious’ about contributions.
‘The vast majority of people who are auto-enrolled are at the lower end of the income scale and a few pounds a month is extremely valuable to them,’ he said. ‘The government is right to be cautious about contributions because we have to take people on the journey of increasing contributions and get them to a point where they really value the money they are saving.’
It is important that auto-enrolment does work as a ‘journey’ for savers. But, as the Aviva research shows, many have joined this journey late and, unless contribution levels increase quickly, it seems likely that many will be left woefully short when they reach their retirement age.
The DWP and its latest advisory board for auto-enrolment unveiled last week face some tough decisions over the coming months as we head into the crucial phase of this policy.