DC auto-enrolment next steps
Since the introduction and popularisation of defined contribution (DC), individuals have had a greater influence over their current and future financial position through choice over investment and contribution decisions. So why is this relevant now more than ever?
Auto-enrolment is impacting the UK’s DC pension environment in these key ways:
- More employers than ever are hitting staging dates
- Minimum contributions are set to step up from April 2018
- Increasing contributions brings a risk of increased opt-outs
There is a general agreement that the Government’s suggested 8% minimum contribution levels, coming into force from April 2019, are inadequate, and there remains a huge risk that savers will think the de facto ‘recommended’ level is enough. Imagine someone with limited pension knowledge seeing their total contributions increase from 2% to 5% to 8% over the next couple of years – they could be excused for thinking they were doing the right thing to see themselves through to retirement, and certainly that stretch may be all they can afford. This discussion is not likely to go away soon, but the outcome will no doubt be significantly affected by the relative success of the planned escalation and the level of opt-out rates seen.
Affordability is a key risk. Many people who were happy to be auto-enrolled when they were only contributing 1% of their own earnings, will really feel the bite when that escalates to 5% in 2019. This will be compounded by the fact that it will probably be low earners who are the most likely to opt out, yet low earners are also less likely to have other savings or assets to support them through retirement.
So, assuming that employers want to retain as many people as possible in their pension plan there are a few steps they can take:
Think about design
Is your plan clear, simple to understand and used by your members? It is worth assessing whether there are options that suit the full profile of your employees. For example, is there matching in place to incentivise low-earning individuals, and at the other end of the spectrum are there alternative vehicles for high earners who may have pension tax issues?
Think about engagement
If you are losing members at the first rate hike, this does not bode well for the second. You need to address this in a number of ways. Firstly, change should be communicated clearly across the organisation with plenty of notice – no one likes an unexpected hit to their pay packet. You may need to think about clever and engaging ways to do this rather than the bare minimum required. Also, shifting members’ focus from the additional cost they are facing to the additional ‘free’ money they will receive from their employer and through tax relief if they stay in the scheme may help win some over.
Secondly, you want your employees to buy into the concept of needing and wanting a pension, setting aside the costs. If people truly understand the scheme, the value they get from matched contributions and want to have some comfort in later life, many will put in the effort and look at their spending today if necessary.
Think about fees
On the last point, this is something that can be done regardless of scheme size and structure. Arguably a positive change is already underway, driven by master trust growth and increasing pressure on the transparency of investment costs. Lower costs for employees mean more money remains in the pension pots. Master trusts are the vehicle of choice for employers setting up new savings arrangements, and a key reason for their popularity is their ability to offer lower costs to members (and employers).
Think about vehicle
Many employers are considering the best use of their available governance budget. A large number of schemes are moving to outsourced arrangements as a consequence. There is nothing new to the logic – the benefits of outsourcing have been seen in the UK in many fields. Outsourcing can have a radical impact on businesses focussed on making significant changes, and these changes can be motivated by improving quality, saving money and reducing risk. These three outcomes have huge significance in the pensions industry, in the face of ever-increasing legislation and employer costs.
A comforting note is that the Regulator has similar views on the direction the market is travelling in, which hopefully will lead to a more settled environment in the near future. The bodies responsible for monitoring pension trends and behaviours see the obvious upsides and economies of scale for members if they are in a small number of very well-financed and well-managed pension schemes.
The planned Pensions Bill takes further steps to protect members’ benefits. It will align the protections in place for members to ensure greater consistency across trust-based and contract-based schemes.
The success of auto-enrolment can only be measured with the passage of time, but we know now that there is no way to catch up on missed years of saving, so the message has to be to focus on what you can do to support your employees that is within your control.