AE reforms should focus on middle earners, says report
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The recently announced change to state pension uprating strengthens the case for higher auto-enrolment contributions, a new report produced by London Economics for master trust the People’s Pension suggests, stressing that these should be targeted at middle earners.
With the change to the triple lock meaning that the state pension will in future be pegged at roughly 30% of median earnings, the report by economists Carl Emmerson and Max Molaro at policy consultancy London Economics argues that private saving will need to rise if savers are to reach the same level of overall retirement income they would have had without the change.
“The state pension provides the foundation for retirement income, and its future level and uprating will directly affect how much people need to save privately,” Emmerson said.
“Our new research shows that different groups face very different retirement challenges. Middle earners are where the evidence of under-saving is strongest, while policymakers need to be cautious about measures that could put further pressure on lower-income households today,” he explained.
The paper recommends:
- increasing default minimum automatic enrolment pension contributions;
- retaining a lower qualifying earnings threshold to protect lower earners from higher default contributions;
- provide employees with the option to opt down to the current minimum contribution rates;
- increasing the upper earnings threshold for automatic enrolment – the salary cap for minimum contributions – to around £65,000 and indexing it to earnings; and
- modernising national insurance credits to support part-time and part-year workers better, alongside considering mandating employer pension contributions from the first pound earned, including for employees who opt out of contributing themselves.
Patrick Heath-Lay, chief executive at People’s, said the report makes a clear case for ensuring the UK pensions system is better integrated, so that state and workplace pensions combine to reach a target level of income in retirement.
If the state pension is to be held steady at 30% of median earnings, “then the case for increased private saving is strengthened”, Heath-Lay said.
However, he warned policymakers to be cautious: “There is a trade-off between the simplicity that has brought more than 11m people into retirement saving via automatic enrolment and the need to protect lower earners from the impacts of higher contributions. Careful thought needs to be given to how to reduce risks for the lowest earners if a flat increase in contributions emerges as the Commission’s best option.”
The report cites official estimates suggesting that about 40% to 50% of people in middle-earning groups are not on track to meet their target replacement rates under triple lock uprating, set to rise under the reformed triple lock. Lower earners – which the government has said the Pensions Commission will focus on – have more immediate financial pressures that mean long-term saving could put them at risk of not having sufficient money day-to-day, as well as potentially leading to oversaving.
Emmerson suggests that someone earning £40,000 a year who retires at 63 and has been saving at the minimum auto-enrolment level would replace 62% of their previous take-home pay with the current triple lock. However, this falls to about 55% under the planned partial triple lock, but raising default contributions from 8% to 12% of qualifying earnings would bring them back up to 63%, according to the research. The paper argues that median earners would need about 74% of their former income to maintain their living standard in retirement.
On Tuesday, Baroness Jeannie Drake suggested at the Pensions UK Annual Conference that higher contribution rates are likely to be among the Pensions Commission’s recommendations, according to Isio partner Richard Hasson.
“Baroness Drake was clear that increasing automatic enrolment contributions, particularly employer contributions, is likely to be central to the Pensions Commission's recommendations. Alongside this, there is a strong focus on tackling inequalities affecting women, lower earners and the self-employed, while maintaining a sustainable state pension,” Hasson said.
“There was cautious optimism about government backing, but a clear message that lasting progress will depend on long-term political and industry consensus to finish what Turner started,” he added.
However, some are warning that any changes will, once again, come too late for Generation X, now aged about 46 to 61, whose careers largely took place after the closure of defined benefit schemes to new entrants but before automatic enrolment. The Pensions Policy Institute recently said 45 to 54-year-olds are set to have smaller DC pots than both younger and older cohorts.
Under a phased auto-enrolment increase from 2030, someone aged 60 would see their pension pot go up by just £2,000, with contributions not even reaching 12% before they reach state pension age, according to Standard Life. The provider said those who can afford to might need to voluntarily increase contributions, but it added that wider support is needed.
“The saving challenge remains greatest for those closer to retirement, particularly people in their late 50s and early 60s,” said Catherine Foot, director at the Standard Life Centre for the Future of Retirement.
She called for targeted intervention to help more people remain in work for longer, including supporting people who are balancing caring responsibilities or living with ill health to access flexible employment opportunities, strengthening their retirement security and financial resilience.
“Improving retirement outcomes requires a long-term strategy for future generations, but there is an equally pressing need to address the challenges facing those approaching retirement today,” she said.
