Big pay rises, paying off a mortgage or getting higher tax incentives have little or no effect on pension savings behaviour, a new report by the Institute for Fiscal Studies has found. The research institute therefore proposes bringing in higher default pension contributions for higher earners or a form of auto-escalation.

  

Fewer than one in a hundred private sector employees actively increase their pension contribution rate in response to a 10% pay rise, the IFS has found.   

   

Even among employees aged 50–59 – where it would be plausible to think that retirement is starting to become a consideration and the mortgage has been paid off – there is no relationship between pay increases and changes in the fraction of their pay they choose to contribute to a pension, the IFS said in its latest report, ‘When and why do employees change their pension saving?’, funded by the Nuffield Foundation.   

   

“Many employees might baulk at the idea of devoting more of their pay cheque to their pension in today’s high-inflation environment,” said Laurence O’Brien, a research economist and co-author of the report. “But when people do have extra cash available, either because of a pay rise, paying off their mortgage or their children leaving home, very few employees put any of this extra cash into their pension.”  

   

Given concerns that many private sector employees are at risk of undersaving for retirement as most are now in defined contribution arrangements, he said the question arises whether policy changes could prompt people to increase their pension saving when it makes financial sense to do so.   

   

“For example, higher default employee pension contribution rates at higher levels of earnings, particularly above the higher-rate threshold, or at older ages could help many make better saving decisions,” O’Brien proposed.  

   

This is an idea similar to ‘auto-escalation’, whereby a pay rise automatically leads to a higher pension contribution.  

   

While better finances do not always lead to more saving, the IFS has found evidence that people do up their contributions slightly when they move from renting to having a mortgage. Conversely, it also found that some life events influence people to reduce their contributions, such as the arrival of a first child, and concludes that relevant communications at the time of life events – for example by mortgage providers – could nudge people into saving more.  

   

The IFS report also emphasises that people’s participation in workplace pension schemes increases only slightly in reaction to the 40% tax incentive for higher earners, the report states, and pension contribution rates “also only respond mildly to this tax incentive”.   

 

It adds: “If anything, pension saving has become even less responsive to this tax incentive since the roll-out of automatic enrolment. This is consistent with automatic enrolment bringing more ‘passive savers’ into workplace pension saving.”  

 

The idea that tax relief is an incentive has previously been questioned, however. Speaking at an event organised by the Chartered Institute of Taxation and the IFS last summer, Charlotte Clark, director of regulation at the Association of British Insurers and a former head of pensions at the Treasury and the Department for Work and Pensions, said pensions tax “does not incentivise saving, it rewards it, and there is a very different mentality between those two things... If you believe something incentivises something, then you’re looking at behavioural change. If you believe it rewards it, then it becomes a question of fairness and who do you want to reward.”   

   

The IFS recently proposed a number of changes to pensions taxation, including altering national insurance contributions relief on pension contributions and pension income, capping the 25% tax-free lump sum, while making the annual and lifetime allowances more generous. 
 

     

The institute is holding an event about its analysis of pension saving incentives on 8 March.