In the first of a series of articles looking ahead to next year, Alastair O’Dell investigates how phase two of the Pensions Review will aim to tackle the ticking timebomb of pensions adequacy.
The simple truth is that existing defined contribution (DC) pension arrangements do not ensure most members will enjoy an adequate retirement income.
The current minimum combined employer-employee contribution rate is 8% under auto-enrolment rules, while the average contribution rate for public sector defined benefit schemes is 28.5%.
The Pensions Policy Institute (PPI) suggests a median earner requires combined contributions of about 16% to replicate working life living standards, according to Daniela Silcock, head of policy research at the PPI, noting this estimate does not factor in housing costs.
Calum Cooper, head of pensions policy innovation at Hymans Robertson, says: “The goal for the private sector is to try and level up towards what public sector is doing. Even getting to 12% would be a big step forward.”
Emma Reynolds, the pensions minister, said in October that phase two of the government’s Pensions Review “will look more widely at further long-term steps we can take to improve pension outcomes, including assessing the level of savings people need to achieve the retirement that they want”.
She certainly has her work cut out. Successive governments have dodged the issue due to affordability. Beyond tinkering with investments, a combination of member, employer or state contributions need to fill the gap.
The state pension bill is already set to increase rapidly due to a declining workforce-pensioner ratio, with the triple-lock compounding its long-term cost.
Meanwhile, real wages have fallen since 2008 in most areas of the country, according to the Trades Union Congress, and employers are set to be squeezed by a 1.2% increase in National Insurance contributions.
“It feels like we’re a long way off getting people to save more into pensions,” says Cooper. “All the difficult stuff is still to be tackled – there are all sorts of puzzles to solve. There’s a big risk that we end up with analysis paralysis, and kicking it down the road.”
A cross-party consensus is likely needed to survive changes in government, with support required from stakeholders including the Treasury and pensions industry.
“We’ve recommended there should be an independent review, like the Turner review in the 2000s, as it’ll be politically challenging to do the right thing unless everyone’s behind it,” says Cooper.
An emerging solution
The first task of phase two is to decide exactly what the government is seeking to achieve.
“We don’t really have an agreed upon definition of adequacy,” says Silcock. “Aiming for retirement income throws up questions – not just how much you want people to save but where that money should come from. You can’t make private pension policy independently.”
Retirement incomes also depend on means-tested benefits, disability benefits, post-retirement earnings, potential inheritance and non-pension savings including ISAs as well as health issues and caring responsibilities.
It is reasonable to assume that the review will focus on ensuring a minimum standard of living, while increases in contributions will need to be balanced with affordability.
Encouraging employees to increase contributions is unlikely to be effective. “Engagement does not work – we’ve tried that,” notes Silcock.
Moving to compulsion may work – but this would be unpopular and an identical outcome could be achieved elsewhere. “One option is to increase how much employers pay and not increase how much employees pay,” says Silcock.
Employer rates could be increased slowly and partially replace pay rises that employees would otherwise have received. In economic terms it makes no difference how contributions are labelled, at least after an initial period. But it would be far more palatable for employees to forgo a pay rise they had never received.
“While I don’t know that’s what the government will decide to do, it seems to be the logical next step,” says Silcock. “But I don’t think it would be something that the government would explicitly say to individuals.”
Cooper agrees with this approach, suggesting employers could be provided with a couple of years’ notice before being required to make 0.5% annual increases for a decade.
The government is also likely to want to increase inclusivity. “They could make it compulsory for the employer to contribute for everybody, whether the employee contributes or not,” adds Silcock.
Further reading
PLSA Conference: The complex pension adequacy picture (15 October 2024)
National insurance hike ‘terrible news’ for pension adequacy efforts (30 October 2024)
Employers recognise pension provision shortfalls, research shows (10 September 2024)
[2]https://www.taxresearch.org.uk/Blog/2024/04/29/real-wages-have-fallen-since-2008-in-most-areas-of-the-country/
