Auto-escalation pensions

    Auto-escalation pensions

    Auto-enrolment is currently being implemented across all UK businesses. By 2018 every employee will have been enrolled into a workplace pension to ensure they are saving towards their retirement. The programme has been widely heralded as a success, with opt out rates well below expectations.

    But doubts remain over whether the contribution levels will allow savers to accumulate the funds to provide a significant income in retirement. Minimum rates currently stand at 2 per cent (1 per cent from employer, 1 per cent from employee) this will rise to 8 per cent by October 2018 (3 per cent employer, 5 per cent employee) but there are fears that such an increase – even with a hike in employer contributions – will see more workers opting out. At the same time, 8 per cent is well short of the minimum level generally accepted as necessary to accumulate adequate savings. So what can be done to encourage savers to do more?

    In order to manage better contribution rates, analysts have suggested auto-escalation, a scheme that allows employers to increase member contributions annually by a set increment, most commonly 1 per cent. The goal is to increase the amount you contribute to your pensions every year. The plans have been growing in popularity in the US. Typically savers will start with a 5 per cent contribution to a 401(k), the country’s retirement savings plan, and then add a 1 per cent increase every year. The theory is that, with a pay raise of 3 per cent, workers probably will not notice the increase to 401(k) contributions. The idea is that over time the 401(k) grows with even more momentum due to the increased contributions. Contributions can be increased by up to 5 per cent every year.

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    While this is a good strategy to retain pension savers, critics have pointed out that it could pose challenges for employers who are already struggling with implementing auto-enrolment.

    Earlier this year, the then pensions minister Steve Webb highlighted the importance of starting the process of auto-escalating pensions contributions soon. But with Ros Altmann newly installed in the hot seat, we are yet to see whether these changes will be implemented.

    Not the main driver

    “It is a key part of the auto-enrolment strategy to create a significant number of new savers,” says Tom Nall, director of Workplace Solutions at Simplybiz. “It has challenges of course, but if you look at the research from the Department for Work and Pensions (DWP) on reasons for opt-out, it clearly shows that affordability alone isn’t the main driver.”

    According to research conducted by the DWP in November 2014, the overall opt-out rate across all 46 employers surveyed was 12 per cent of those 2,600 workers who were automatically enrolled. Most individual employers had seen between 5 and 15 per cent of their workers opting out following automatic enrolment.

    Some of the most commonly cited reasons for opt-out include affordability, low contribution rates and concerns about pensions savings as a vehicle. A key issue for older workers was that they feel pension contributions won’t make a material difference to their retirement, but with the introduction of pensions freedom reforms, this will hopefully change as even over a shorter period a pension will become a tax-efficient savings vehicle boosted by contributions from employers.