Psychologists believe that when we imagine our future selves, we think of them as strangers and are likely to make financial decisions that neglect them. The cost-of-living crisis has brought this issue into focus, but employers and trustees are reluctant to engage with members about their retirement security because they worry it may constitute financial advice. What is the impact of advice boundary anxiety, and how it is impacting defined contribution (DC) member outcomes?

 

 

The cost-of-living crisis has led many lower earners to stop contributions to their pensions. This is evident in Sandra Wolf’s recent review of HM Revenue & Customs data, which points out that ‘the number of scheme members contributing dropped in 2022-23 from a year earlier, while the average amount saved in a private pension went up over the same period.’

 

However, many employees do not realise that by opting out of pension contributions, they are effectively giving themselves a voluntary pay cut. 

 

In a previous article in July, we discussed a hypothetical worker who is currently 27, sitting on a starting DC pot of £6,000, grossing £35,000 per annum and contributing the 5% minimum required under auto-enrolment (and receiving the 3% minimum from the employer). This worker could end up with an estimated annual cashflow of £8,200 from this pension pot, which works out to a £683 monthly top-up to their state pension. 

 

Let’s assume that in reaction to the cost-of-living crisis, the worker opts out of DC contributions. This would save them £86 per month today. Not only would this cost them £683 per month in retirement, but they would also lose out on the 3% contributions from the employer. As a result, the worker would earn £863 less per year, or £79 less per month. 

 

 

In our previous article, we also explored a scenario in which the hypothetical worker consolidates their pension pots and as a result becomes more engaged with their pension and increases their personal contributions from 5% to 8%. As a result, the worker would increase their retirement income by £2,500 per year, which is about £208 extra per month.

 

Our hypothetical worker may assume they would have to sacrifice £2,301 - £1,438 = £863 per year, or about £72 per month. However, the cost of these additional £208 per month in retirement is only £51 per month today. 

 

 

Unfortunately, neither employers nor FCA-regulated firms providing retirement savings products are doing enough to help members understand the interplay between their personal pension contributions, their take-home pay and future outcomes. Communications often focus on either just the impact on take-home pay, or the impact of increased contributions on future retirement income, but rarely on both.

 

Another unhelpful angle often used around tax year end is the tax savings from increasing pension contributions. However, the monthly tax and national insurance (NI) savings from the minimum auto-enrolment contributions is £24 + £10 = £32 per month, and the additional savings from increasing personal contributions is £15 + £10 = £25 per month. While not negligible, these savings pale in comparison to the impact on future retirement security. 

 

 

Another shortcoming of member communications is that they rarely help employees imagine their future selves in retirement. Chris Budd, a financial wellbeing expert, explains that when people imagine their future selves, the part of the brain they use is the same as when they are imagining someone other than themselves. In other words, there is a disconnect between our current selves and future selves. 

 

This idea builds on an extensive body of academic research about ‘future self’ theory. More specifically, feeling close to one's future self can motivate people to spend less today to help themselves more in the future. However, pension communications today do not do much to encourage greater continuity between the current and the future self. 

 

 

 

HR and payroll professionals are closest to members when they enrol in a pension, which is arguably one of the most important financial decisions for their future selves. However, they are often reluctant to explain to employees the impact of increasing or reducing their pension contributions because they are not qualified to give financial advice and worry that much of what they say may be construed as such.

 

The Financial Conduct Authority (FCA)’s ongoing advice boundary review focuses on FCA-authorised firms and specifically ‘the boundary between financial advice and guidance available for retail investments and pensions’ in both accumulation and decumulation products. The regulatory review will aim to clarify what activities would constitute financial advice and create a new regulatory framework for ‘support [which] could be offered without explicit charges.’ The new support framework will also ‘suggest products or courses of action based on a target market the consumer has been identified as belonging to, rather than fully individualised support.’

 

While the FCA explicitly states that firms ‘should not be overly reticent to offer support because they are hesitant to come too close to the boundary,’ employers (and HR and payroll professionals working for them) are not included in the advice boundary review. The FCA points out that ‘in most cases pension trustees and employers should be able to help members without needing to be authorised,’ but is open to hearing from DC schemes without FCA authorisation about the specifics concerns they have.

 

 

 

To provide additional clarity, in 2021 the FCA and the Pensions Regulator (TPR) released a guide for employers and trustees on providing support to members on financial matters without needing to be subject to FCA regulation. 

 

The guidance specifies that ‘where you are thinking about helping employees with their workplace pension scheme, wider retirement planning, or other aspects of their financial affairs, you will generally not need to be authorised by the FCA.’ Factual information does not count as financial promotion or advice, unless the materials also ‘promote the […] pension scheme, encourage a switch, or persuade individuals to join it’ other than under auto-enrolment. 

 

The FCA and TPR continue to clarify that FCA authorisation would be needed only if trustees and employers are ‘arranging transactions’ or ‘providing regulated advice’ and receive a ‘commercial benefit’ for helping employees, for example via commission or discounts on premiums and payments. 

 

 

 

Even with the advice boundary review still in progress, the TPR and FCA guidance on using factual information already allows member communications to go much further than they typically do. Yet trustees and employers stop short of helping members connect the dots between their take-home pay, pension contributions and future retirement outcomes. The advice boundary review will hopefully formalise the offering of support based on ‘people like you.’ But in the meantime, there is so much more that the pensions industry could be doing to support members in a much more holistic way.