Why now might not be the right time to increase auto-enrolment pension contributions
Financial resilience has become a central issue over the past two years as people continue to live with the fallout from the Covid-19 pandemic and, more recently, the effects of inflation.
Financial services company Hargreaves Lansdown recently released the second edition of its HL Savings and Resilience Barometer, produced in collaboration with Oxford Economics.
The barometer finds that:
- Financial resilience increased through the pandemic, largely due to periods of forced saving. But those gains have almost been wiped out by rising inflation. Surplus incomes, cash savings and pension investments have fallen across all demographic groups.
- Real disposable income is estimated to have fallen by almost 3% in the past three months and will remain stagnant over the coming year, despite government support packages.
- 41% of households estimated to have raided savings or taken on debt to fund spending.
Steeper fall in resilience
Nobody will escape the cost of living crisis unscathed. But, for some households, it means an even steeper fall in financial resilience. In fact, more than 40% of the population will face significant challenges to their personal finances. Households in the bottom 40% of incomes are projected to suffer a three times greater fall in their financial resilience compared with households in the top income bracket. Financial inequality across the UK will worsen.
Auto enrolment changes could make things worse
Against this backdrop, proposed pension policy changes could make lower income households even worse off if not carefully timed.
There are two proposed pension policy changes:
- Automatic enrolment expansion: removing the lower limit on qualifying earnings, so contributions start from the first £1 earned, and reducing the entry age from 22 to 18.
- Minimum pension contribution: raising the minimum contribution to 12% for all employees (6% from employee, 6% from employer).
Based on models from the Savings and Resilience Barometer, the impact of these changes could shrink disposable income, rainy day savings and net financial assets even further by 2029.
Rainy day saving should be a priority
While auto-enrolment has been a success, the current economic environment restricts the potential of the proposed policy changes when it comes to financial resilience. Introducing an enforced increase at a time when people’s budgets are buying less and less would come across as tone deaf to the cost of living crisis. It could result in the opposite of the intended outcome, rather than boost private pension provision, employees could freeze contributions or opt out of schemes.
We recommend that employers use a matching contribution basis to incentivise those employees that can afford to pay more to increase their payments, while ensuring that those who can’t won’t be pushed into debt by joining the pension.
In our Five to Thrive approach, building adequate rainy-day savings is identified as an important step in household resilience and should be prioritised before employees begin to think about putting additional money aside for later life.
Although increases to minimum pension contributions could be beneficial long-term, the proposed changes do not adequately consider the nation’s current ability to save for the short term and may erode short term resilience, particularly for the poorest households.
Nathan Long, HL Senior Analyst, says: “The proposed enrolment expansion amendments should only be introduced when any lingering effects of the cost of living crisis have passed.
“Exploring how to encourage pension members to increase their contributions voluntarily may also remove the financial burden on members if they are concerned about affordability in the short term.”
Read more about how the changes to auto-enrolment might affect your employees here.
Original article: Is now the right time to increase auto-enrolment contributions?
In partnership with Hargreaves Lansdown
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