Workplace pensions: Fixing the slow puncture

Pension adequacy can only be achieved if Government, pension providers and employers agree to a collective, longer-term plan.

A slow puncture rarely announces itself dramatically. There is no sudden bang and the vehicle may continue moving, seemingly unaffected. But over time, if the warning signs are ignored, a manageable problem can become a much more serious one.

In automatic enrolment, we have a fantastic vehicle for workplace pension savings, with nearly nine in ten eligible employees now saving into a workplace pension. But without substantial maintenance, there is a risk we will not reach the desired destination of a secure retirement for the UK population.

The clearest warning yet

Earlier this year, the Pensions Commission’s interim report provided the clearest warning yet. Tasked with addressing the issue of pensions adequacy, the Commission estimates that 15 million people are currently under saving for retirement, potentially rising to 19 million by 2050 without action. Low and middle earners are particularly exposed, with around half saving only at minimum automatic-enrolment levels and having little else to fall back on.

The consequences may not become fully visible for decades. But the people affected are already in the workforce, receiving payslips, making contribution decisions, and building their retirement savings. This makes pension adequacy an issue that employers need to engage with, not simply a matter for government or pension providers to resolve, and the topic provided the basis for an interesting discussion I hosted at REBA’s Future of Pensions Summit in September.

For reward and benefits professionals, the challenge is that statutory minimum contributions have often become the default rather than the foundation. Employees may reasonably assume that because they have been automatically enrolled and are making the mandatory contributions, they are on course for an adequate retirement. In many cases, that assumption will prove overly optimistic.

Prior to the Commission’s interim report, Royal London sponsored some research by Oxford Economics illustrating the size of this expectation gap. It projects that by 2040, only 36% of households relying on defined contribution pensions will achieve their target replacement rate, which is the proportion of pre-retirement income needed to maintain their living standard. Just 26% are expected to meet the moderate Retirement Living Standards benchmark.

These are not merely statistics about life after work. Financial insecurity about retirement can affect people throughout their working lives.

Workplace solutions are needed

Employees who lack confidence in their pension may experience greater financial anxiety, feel compelled to work longer than planned, or find themselves unable to retire when health issues or caring responsibilities make continued employment difficult. This will create challenges for employers around managing the wellbeing and engagement of their employees and is likely to make workforce planning more difficult.

The workplace is where much of the solution needs to be delivered.

Oxford Economics modelled five reform scenarios, including lowering the automatic enrolment age to 18, removing the lower earnings limit, and increasing combined employer and employee contribution rates to between 10% and 14%. Its analysis confirms that while higher contributions reduce employees’ disposable income in the short term and increase costs for employers, these impacts are relatively modest and would create a more financially secure retired population.

Over time, it will also have a positive impact on UK economic growth. Oxford Economics found that additional pension assets would support investment and economic activity, with the scenarios modelled increasing annual UK GDP in 2060 by between £0.7 billion and £6.2 billion.

Credible reform

Of course, financial pressures created by increased pension contributions are likely to be felt most acutely by lower-paid workers and smaller businesses operating with narrow margins. That is why the answer cannot simply be to increase contributions immediately, or even within a short period of time.

A credible reform programme needs a clear long-term destination and sufficient notice for employees and employers to adjust. Crucially, international experience suggests that gradual increases over several years are more manageable and give businesses time to incorporate higher contributions into pay, reward and workforce strategies.

Good workplace financial wellbeing

Employers do not, however, need to wait for legislation before acting.

Reward and benefits teams can assess whether their workforce is on track for adequate retirement outcomes, examine whether contribution structures encourage employees to save more, and make pension contributions more visible as part of total reward. Matching arrangements, contribution escalation and targeted communications can all help, provided they are designed around the characteristics and finances of the workforce.

HR and wellbeing professionals also have an important role. Pension saving should not be presented in isolation from shorter-term financial resilience. Employees need support to balance retirement saving with debt, housing costs, emergency savings and other more immediate priorities. Good workplace financial wellbeing is important to help people achieve that balance.

Automatic enrolment has got millions of people moving in the right direction on the road to saving for retirement. Government, pension providers and employers must agree to a collective, longer-term plan, to ensure this journey doesn’t stall and we reach our shared destination of good pension outcomes for all.