Nudging your way to a higher retirement income

07 June 2023

Last month, the Institute of Fiscal Studies published its 37-page Pensions Review paper entitled ‘Challenges for the UK pensions system: the case for a pensions review'.

The new IFS-led review is supported by the Abrdn Financial Fairness Trust and has received valuable input from luminaries from the world of politics and the pensions industry including Alastair Darling, David Gauke, Mubin Haq, Joanne Segars and David Sturrock.

It will run for two years. Many have speculated that this review is happening because of the lack of enthusiasm from both major political parties to fund a full Pensions Commission.

It's certainly true to say that if a new Pensions Commission were to be backed by the new government after next year's general election, it would have to fill very large shoes. As we know the last Commission in 2003-2005 led by Lord Adair Turner, came up with the central recommendation ‘for employers to enrol most employees into a workplace pension, including a requirement for employers to make at least a minimal amount of pension contributions as long as the employee does not choose to opt out of the arrangement.'

And so auto-enrolment was born and finally completed its roll-out across UK employers of all sizes by April 2017. Today, more than ten years on since it began roll-out, more than 10.7m have been auto-enrolled.

The IFS report states that it will assess the impact of events over the last 18 years since Lord Turner published his final report and recommendations. We all know what's happened as we've lived through it:

• The Great Recession (Jan 2008 to July 2013) - a banking crisis which triggered a very lengthy period of economic malaise in which UK household incomes stagnated but house prices and international equities rose strongly
• Pandemic - a period of forced economic inactivity for particular sectors and growth in remote working and e-shopping
• Ukraine War - precipitating a period of high inflation, impacting mortgage interest rates and double-digit inflation of the cost of many goods and services, now widely recognised as ‘the Cost of Living crisis'.

Events since early 2020 in particular, pushed up the UK's public sector net debt levels to the highest we've seen since the early 1960s. Today it amounts to 97.2% of the UK's gross domestic product.

In terms of the UK people's personal wealth and pensions savings levels much has also changed since 2005:

• The increase of self-employment so that today more than one in six (17%) of the working age population in the UK are self-employed - that's more than 5 million people at its peak in early 2000. That in itself would not be a concern except that less than 20% of this growing group - just 800,000 in 2018 - were saving into a personal pension.
• Decline of participation in the much more generous defined benefit (DB) pensions so that today under 12% of men, and the same percentage of women, are saving into a DB plan, as defined contribution (DC) plans quickly came to dominate the pensions landscape.
• Pension freedoms was launched at the back end of the Great Recession to enable people approaching retirement to have more control over how they use their retirement savings. But it arguably left some lower-earning groups more exposed than ever to poverty in old age.
• The spectre of pensions ‘under saving' naturally raised its head as it became increasingly clear that, in a low savings interest rate, low growth economy, putting less than 10% of salary into your personal pension would probably leave you short in retirement. The IFS paper puts some numbers around all this. For example, 61% of middle earners working in the private sector contribute less than 8% of their total earnings into their workplace pension scheme.
• Earnings have not kept pace with the rise in cost of UK property to such as degree that we are seeing a decline in homeownership even amongst those now approaching retirement age. Right now, 10% of UK people born in the 1960s are still private renters and by 2035 one in five (20%) of those approaching state pension age will still be renting their home.
• The ageing of the UK population has meant that already 19% of the UK population is over 65. The government's reaction to this trend and the inexorable rise of the national bill to pay for the state pension is to increase the state pension age. It's set to rise next to age 67 for everyone born after April 1960 - those Generation Xers again.

This could make sense as a strategy if it was not feeding straight through to the number of over 60-year-olds living below the official poverty rate. One of the major problems is that 35% of men, and 40% of women in their late 60s, are disabled and these percentages get worse in less educated groups. To go with the pension changes we need a societal change, that stops seeing disabled people as slackers and instead embraces the adjustments that are needed to enable them to work on longer.

Again, the poor and disadvantaged seem to be in the firing line if state pension ages rise, particularly as the lowest earners rely most heavily on the state pension for retirement income: over 17% of pensioner households now rely entirely on the state pension to afford to retire, according to Equitini's research. This is the highest level recorded since 1995/96.

So, what is the IFS-led Pensions Review likely to recommend when it reports in two years' time?

One likely proposal is to ask employers and employees to increase their auto-enrolment pension contribution rates. The IFS might recommend that total employer and employee auto-enrolment contributions rise steadily from the current eight % total, towards 12 %, with that amount being on total earnings - perhaps with the employer and employee paying 6% each. That would amount to a more than doubling of the current bill falling on many employers as currently they only have to contribute 3% of qualifying employees' salaries. That's not likely to be a popular measure in an economy which is set to continue in no/low growth mode for some time. And it could even lead to persistent low earners over-saving.

Nudging

Auto-enrolment increases only takes us so far. What about the increasing numbers of the self-employed - only a minority of whom are saving anything into a personal pension? For these people, it surely makes sense to try to target them for a combination of simplified advice, supported by online ‘savings scenario exploration' tools and behavioural economics - sometimes called ‘nudging'?

After all, the key issue is to get more of the population setting more aside for their eventual retirement to avoid exposure to a poor quality of life if and when they choose to retire, are forced into retirement by ill health, and/or lack of access to well-paid work.

Here's some food for thought for providers that are self-employed (or others) contributing to a self-invested personal pension (SIPP) outside of workplace pensions: why not use techniques we've all been exposed to in the retail and general insurance markets for decades, to encourage them to get on track with their pensions contribution levels and then stay on track?

For example, if your self-employed policyholders pay in 12 monthly pension contributions of over £300 per month, then award them a bonus contribution paid in by the provider at the end of the year. Or alternatively, reward them with an annual management charge discount on the following year's contributions much like the no claims bonus idea for car insurance? It costs less to collect regular contributions that have remained constant rather than stopping and starting, so you would simply be returning some of those cost savings to the regular contributors.

Advice is always going to be needed as well: it may make more sense for the self-employed to be able to retain ready access to their savings in case their business does hit a cashflow squeeze. This has been a major problem for many micro businesses as they emerge from the pandemic. It's often a major issue when small businesses are expanding - many simply run out of money trying to fulfil big new orders they've just secured. A financial adviser might advise some of the self-employed to hold their long-term savings in ISAs, instead of a pension, if the need for this level of flexibility is anticipated.

Retirement savings illustrations also need to be made more engaging, dynamic and interactive - so that it is easier for the time-poor self-employed to quickly explore what an increase in regular contributions could mean in terms of prospective retirement income.

Why not offer a mobile app and online portal-based tool which enables them to explore adjusting contribution levels upwards to bring them into line with their target retirement income from, say, age 67? The tool could suggest a range of retirement living standard targets perhaps in line with the three Retirement Living Standards calculated by the PLSA. Ask them to pick one and build a savings plan around that.

To increase the probability of reaching their selected living standard, you could encourage them to increase their contribution in line with CPI (much like index-linked DB pensions do). Then they can see what impact steadily increasing contributions has on their retirement income and retirement age prospects.

In the digital age which the pensions world is now embracing, spurred on by new Consumer Duty obligations, providers which apply behavioural economics and build this thinking into attractive digital and interactive retirement income planning tools are likely to see their customers move from ‘dis-engaged' to ‘aware' and some even as far as ‘engaged'. I believe it is a realistic goal for our industry to say that nobody should be surprised on reaching retirement and finding out what their pension can buy them in retirement.

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