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29 Feb 2024
by Richard Allen

How to tackle DC pension inequality caused by contribution design

The popular approach to pension contributions works well for those who can afford to save more – but what about those who can’t?

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In an era marked by bold commitments to diversity, equity & inclusion (DE&I) by employers, financial wellbeing strategies, government announcements and regulatory pension consultations, conversations about Defined Contribution (DC) pension inequality have been brought to the forefront. And one area that is slowly surfacing is the role of DC contribution design. 

Emphasis is on the popular matching contribution ladder structures in DC pensions. This financial incentive was introduced to encourage employees to save more for their retirement, and in return the employer would contribute proportionately more too.

This concept, inspired by similar practices in the USA, has become the most common form of pension contribution design. However, this incentive has become deeply constrained for many members. Hymans Robertsons’ Guided Outcomes® analysis has revealed that the benefits of this structure have been disproportionately skewed towards wealthier and older members, especially in light of the current cost-of-living crisis.  

As a result, the incentive is distorting savings between those who can and those who can’t. Many employees simply can't afford to contribute extra to get extra. Simply put, in today’s DE&I language, it’s ‘inequitable’.

For example, there are UK employees working side by side doing the same job, but due to their personal financial circumstances, are paid differently. In more traditional language, matching contribution ladder structures may be curbing upward social mobility. In a liberal democracy such as the UK, hard work is supposed to bring with it the means to progress to a better financial future. 

Is the system fair?

The merit of incentivising employees to save for their future still remains with this matching ladder structure. On one hand, we can quantify the exact extra rewards for the wise saver, and we can remind employees that it offers ‘free money’. But, on the other hand, formal DE&I policies at FTSE companies emphasise eliminating unintended barriers and embedding equality in all practices. This raises important questions about the fairness of the system.

For example, how do we view those returning from parental leave and trying to get back on a financial even-keel – should they forfeit maximum employer contributions in the meantime? Or how about younger employees burdened with student debt and saving towards property deposits - is it ok that they’re instead obliged (possibly not in their best interest) to pay-in their spare income to access maximum employer contributions?  

There’s also greater appreciation that disabled employees have demonstrably higher living costs than average and have to dig deeper than others to enjoy maximum employer contributions. Some may not be able to.  

Finally, some employees come from socioeconomic backgrounds where their communities’ longevity expectations and long-term savings perceptions mean they’re simply more disengaged – it seems inequitable that they should still receive less. 

Taking a new approach 

Many organisations are now looking for ways to support employees with these kinds of challenges - and a new pension benefit approach may be the way to do this. There are alternative contribution design approaches.

Organisations are exploring approaches that align with current support measures, like pension holidays and cost-of-living payments. For example, defaulting employees annually to adequate employee contributions has shown success in maintaining positive savings levels without the need to link them to employer contributions. There are also other structures that can work well in specific industry sectors. 

The potential of change 

A change could have a huge impact. For those employees affected by this issue, Hymans Robertsons’ analysis suggests improvements to retirement outcomes in a typical UK scheme of  up to 28%. Scheme objectives on pension savings gaps could also be enhanced. Such a change could not only address the pension savings gaps but also contribute to upward social mobility, improved longevity, and health spans and positive intergenerational effects. 

At Hymans Robertson LLP, we see opportunities for change and are working with clients to explore and implement innovative and equitable arrangements. In a world where the social narrative is dominated by cost-of-living increases, there’s a real opportunity for a positive change that materially benefits employees – without necessarily imposing unaffordable expense on employers.

For help revisiting your contribution design or to simply discuss these ideas more generally, get in touch.

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