You might end up with a smaller pension thanks to the government's plans for compulsory pensions.
A big pensions shake-up is on the way. Basically all adults in work will be forced to save for a pension unless they opt out. This is known as “auto-enrolment.” I’ve said before that I like the idea, and I still do, but there are some significant downsides. The biggest one is that some people may end up with a smaller pension as a result.
Let me explain why.
As things stand, employers aren’t under any obligation to offer a pension scheme to their staff and many don’t. Especially smaller companies. Smaller firms are often put off by the cost and sheer hassle of organising a pension scheme. In fact, research shows that two thirds of smaller firms in the UK currently offer no pension scheme at all.*
Under the new rules, all these smaller firms will have to set up schemes and hopefully the great majority of employees will start saving for their retirement on a regular basis.
When you look at the employers who will be offering pension schemes for the first time, I reckon the vast majority will use the government’s new pension fund, NEST. Once NEST is fully up and running, employers will contribute 3% of an employee’s salary to the fund while the employee will contribute a further 4%.
That sounds pretty good, but the problem is that many larger employers already operate pension schemes and these schemes are often more generous to staff than required under NEST. For example, I used to work for a company where my employer would contribute 7.5% of my salary to my pension pot as long as I contributed the same amount.
Once NEST is introduced, my former employer might be tempted to cut its pension contributions to 3% of an employee’s salary. That would be understandable. If 3% is the benchmark, why should any employer pay more? So some workers could find their pension pots aren’t growing as fast as they once expected. And when they retire, their pension could be smaller than they expected too.
In other words, many employers may take the opportunity to ‘level down’ their pension contributions.
What’s more, ‘levelling down’ isn’t the only potential problem with the auto-enrolment idea.
Opt outs
I’m concerned that too many workers will exercise their right to opt out of compulsory pension saving. The government is hoping that 75% of working adults will stay in, but I fear that figure may be too optimistic. According to a Legal & General opinion poll, 46% of people will opt out.
Experience from New Zealand also suggests that 75% is too optimistic a target. New Zealand introduced a scheme called KiwiSaver in 2007 which is similar to the UK scheme in some respects. 37% of New Zealand workers have opted out of the scheme and that’s in spite of the fact that it’s actually more flexible than NEST in the UK.
Branding
I’m also worried that the branding for the UK’s scheme will be all wrong too. NEST describes itself as ‘a workplace pensions scheme’ but I fear that will put many people off. The word ‘pension’ is pretty toxic these days thanks to disasters such as the Equitable Life and Robert Maxwell’s pension theft.
As I said in Save for your retirement and win a million, I think it makes more sense to talk about ‘retirement saving.’ A more flexible product that allowed more early withdrawals could also encourage take-up.
New Zealand has followed this branding approach by calling its scheme KiwiSaver and I think we should look closely at that model.
Don’t get me wrong, I still support auto-enrolment. Life expectancy is growing and before too long, there just aren't going to be enough people aged between 22 and 60 to support all the older folk. We all have to take responsibility for funding our old age and auto-enrolment could push 7 million people towards pension saving.
I just fear that it’s going to be harder to persuade people to save than many folk realise. And, on top of that, many existing pension schemes will be damaged thanks to levelling down.
It’s all rather depressing. All we can do is save, save, save.....
* The research was done by the Association of Consulting Actuaries (ACA). Smaller firms are classified as firms which employ 250 or fewer workers.
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