More than ten million people in the UK today can expect to live to see their 100th birthday while the percentage of the population aged 65 years and over will almost double between now and 2050. This is the good news.
But how will the nation pay for all those extra years of retirement? By levying more tax or national insurance; imposing higher retirement ages; or through increased savings? There are no easy answers and the dilemma has been in every government’s in-tray since the 1980s.
There have been at least two Pension Commissions producing lengthy reports, including the 2005 A New Pension Settlement for the Twenty First Century, with its auto-enrolment recommendations, which come into effect this year, in what pensions minster Steve Webb describes as a “much needed seismic shift in pension saving in this country”. Even so it will not be until 2018, with firms employing fewer than 250 people having been given more time to prepare, that the reforms will be fully implemented. Only then will most workers and their employers be contributing 8 per cent of qualifying earnings, including tax relief.
The Department for Work and Pensions (DWP) estimates that auto-enrolment will result in between five and eight million people saving for the first time or saving more in workplace pensions, with extra annual contributions of £9 billion from 2020.
The Government chose auto-enrolment because something had to be done to increase pension savings, but it was unwilling to go as far as full compulsion
Clive Pugh, partner in law firm Burges Salmon, says: “The most compelling driver for reform is the government’s moral responsibility and own financial interest to mitigate, as far as possible, the impending pension poverty which could see almost three quarters of current private-sector staff unable to survive with economic dignity when they retire.”
Patrick Heath-Lay, director of finance and strategic delivery at B&CE, the provider of the People’s Pension, emphasises: “Many people are unaware that they will have to live off a state pension in retirement [currently £102.15 per week].”
The government chose auto-enrolment because something had to be done to increase pension savings, but it was unwilling to go as far as full compulsion. Auto-enrolment where people do nothing and find themselves in a pension scheme works extremely well. Everywhere it has been in place, take-up has risen – inertia is a powerful force. Indeed, experiences from both Australia and the United States have shown that the percentage take-up can be doubled in this way.
Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “Full compulsion by contrast carries with it the political risk of being seen as a tax and of forcing people into a pension when, admittedly for a small minority, it might not be in their best interests. Auto-enrolment was the obvious middle-ground solution.”
The DWP has estimated that auto-enrolment will cost employers around £3.5 billion a year, made up of administrative and initial planning overheads combined with increases in employer contributions which will gradually be pushed up from 1 to 3 per cent by 2018. Government has also estimated that the average administrative cost will be £43 for each person enrolled, with £12 annual ongoing costs, but others have argued that this is a vast underestimate.
The reforms could be especially costly for employers where take-up has traditionally been poor, such as in catering and retail. The current participating rate in a pension plan for retail outlets may only be 20 per cent or less. This has huge financial implications.
Will Aitken, senior consultant at actuarial firm Towers Watson, advises: “Budget for the fact that the vast majority of people are going to stay in. Some 85 per cent of FTSE 100 employers have fewer than 10 per cent of their staff opting out. Employers may have lots of grumbling, unhappy people, but they don’t actually opt out.”
Yet a 2011 Association of Consulting Actuaries (ACA) survey indicates only 26 per cent of employers have budgeted for the costs of auto-enrolment. ACA research suggests that more than 40 per cent of employers may reduce their current pension contributions to meet auto-enrolment costs. In the early years of phasing leading up to the full contribution rate in 2018, the implementation, management, administration and record-keeping costs could quite easily be greater than the cost of contributions.
It can be argued that auto-enrolment is a blunt instrument and some employees will be saving needlessly only to lose out on means-tested benefits. There is also the danger that the minimum level of provision – 8 per cent of qualifying earnings up to an expected maximum of £39,853 – becomes understood as all that is necessary to ensure a comfortable retirement for all. Unfortunately, this is not the case.
For someone on average earnings of £26,000, the projected retirement income under auto-enrolment could be as little as £3,839 before state pension is taken into account.
Clearly the current pension reforms are only a start as 8 per cent of qualifying earnings is not nearly enough to provide an adequate pension. But hard-pressed employers will find contributing even the eventual 3 per cent of payroll a tough proposition. After so much procrastination, there can be no further delay before the UK begins to rebuild its broken pension system.
