Simon Chinnery, Head of UK DC at J.P. Morgan Asset Management, says the pension gap is still something we need to keep stressing to younger employees with tight budgets.
The latest figures from the Office for National Statistics (ONS) found that the rise in young workers saving for retirement has boosted UK pensions to a 17 year high. Although this is truly encouraging, thanks largely to the introduction of auto-enrolment and low opt out rates, past research has shown that the workers most likely to opt out of a pension scheme are the younger generation who feel they can’t afford to save into a pension while having to pay for other financial commitments, such as student loans and saving for a deposit to buy a home.
Therefore, does this change in sentiment signal an increase in awareness and understanding around the importance of pension saving amongst Generation Y? Or is it the consequence of a successful auto-enrolment launch?
If indeed these young people are engaged, the risk here is to assume these savers will continue to be engaged when contributions reach 8%, especially when faced with immediate long-term debt to pay off and their retirement is decades away. While these figures show we’re moving in the right direction, more intervention is clearly needed. The average defined contribution pot size is £35,6001 meaning a median earner has less than a 50:50 chance of reaching their target replacement income from state and private pensions if they don’t contribute more than the minimum required by automatic enrolment.
According to our analysis, the average saver will contribute roughly 7% of their salary to their DC pension plan; and nearly a quarter of these members (22%) may change their contribution rate in any given year. Should they choose to contribute £2,000 less, it is the equivalent of a £165,000 shortfall in retirement (see below chart).
Whilst most people in developed world countries will outlive their income, as illustrated in the below chart, the UK lags behind its peers, especially the US, when it comes to savings shortfalls.
A study2 we conducted with the Pensions Policy Institute identified five of the key issues and potential, accompanying solutions to tackle this:
- Further pension pot access flexibility: To increase saving amongst Generation Y in particular, it was suggested that further flexibility be introduced allowing pension pot access before age 55.
- Behavioural economics interventions e.g. ‘Save More Tomorrow’ (SMarT): The solution is aimed to encourage saving amongst the general population by using behavioural economics and introduce initiatives, such as “Save More Tomorrow” (SMarT), where scheme participants pre-commit to increase pension contributions after each future pay rise; something which has seen great success in the US. Although in the UK many larger employers have just been through a period of overhauling payroll processes to implement automatic enrolment therefore additional administrative costs and further changes would likely be unwelcome.
- Increasing minimum contributions over time: The PPI also suggested the government increase minimum pension contributions over time (for individuals, employers, or both). However, higher contribution rates may not be affordable, particularly for lower earners, leading to an increase in opt outs; undermining the aim of the automatic enrolment.
- Higher minimum contributions for median-higher earners: An alternative option touted was for the Government to introduce higher minimum contribution rates for median-higher earners (who are at greater risk of not saving adequate income in retirement), reducing affordability concerns for lower earners and the risk of opt outs.
- More voluntary, employer-led approaches e.g. contribution matching: Another initiative was to incorporate more voluntary, employer, or industry led approaches. For example, employers matching employee contributions, giving those motivated to save a stronger incentive to do so. This may be more attractive to employers than higher contributions for all workers, as they are targeting rewards at those who value them most.
Whilst the latest ONS figures are a step in the right direction, the challenge remains for the government, adviser community and financial industry to maintain this momentum. This younger generation of savers will make the most significant difference to future capital, and it is essential these stakeholders engage with them to ensure they make sufficient contributions in order to be retirement ready.
1 ABI (2014) The UK annuity market: facts and figures
2 J.P. Morgan Asset Management and Pensions Policy Institute, Increasing pension saving in the UK, August 2014