Reforms for inadequate retirement incomes

Automatic enrolment has dramatically increased private sector employees’ participation in pension saving. But key challenges remain. Most make low contributions: less than half of private sector employees who save into a workplace pension contribute more than 8% of their earnings. A fifth still do not save in a workplace pension so they miss out on their employer’s pension contribution. Low asset returns and increases in life expectancy have made it harder to attain a good standard of living in retirement. 

New research undertaken as part of the Pensions Review, led by the Institute for Fiscal Studies in partnership with the abrdn Financial Fairness Trust, and published today, sets out the scale of this problem and makes concrete policy suggestions in response. 

We find that approximately 30% to 40% of private sector employees (5 to 7 million people) saving in defined contribution pension schemes are on course to have individual incomes that fall short of standard benchmarks in retirement, though prospects look better accounting for partners’ pensions and potential future inheritances. 

Given these patterns, a set of changes to the automatic enrolment system are needed. Some have proposed increasing minimum pension contributions to 12% of earnings for all, which would boost retirement incomes. But we think that a more targeted approach – that helps employees to save more at points in their lives when they might be more able to do so – would be preferable. 

Our suggestions, set out below, would boost private pension saving, but in a way that helps mitigate concerns about the affordability of higher contributions for lower earners. 
In particular, we suggest that:

• There is a strong case for employees to receive an employer pension contribution of at least 3% of total pay, irrespective of whether they contribute themselves. This would benefit the 22% of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to their earnings being too low. Compared with other ways of increasing employer pension contributions, it would be less likely to suppress wages for lower-paid employees receiving additional contributions. A risk would be that this leads to many more employees choosing to opt out of making an employee contribution. Although our reading of the evidence is that the numbers doing so would be small, a government more concerned about this could trial this suggested approach prior to implementation.

• The age range targeted by automatic enrolment should be expanded from 22 to state pension age, to 16–74, to help even more in paid work save for later life.

• Increased default employee contributions should be targeted at people on average incomes and above. The current automatic enrolment default minimum contributions are 8% of earnings between £6,240 and £50,270. Increasing contributions for those with low current earnings risks reducing take-home pay at a time in life when this can least be afforded. Increasing the default minimum on the portion of earnings above a certain threshold would help some middle and higher earners better supplement their state pension. For example, there could be a 12% default total contribution rate for the portion of earnings above £35,000 (around median full-time earnings), with the additional contributions coming from employee contributions. Importantly, many on lower lifetime incomes who have higher earnings in some years would also be helped to save more for retirement. 

• There is a good case for the upper limit on qualifying earnings – which has been frozen at £50,270 since 2021–22 – to be raised, at least for minimum employee contributions. This limit makes it harder for some to make good saving decisions, and the real value of this limit has fallen significantly in recent years. 

• There is a clear need to future-proof the system, by indexing key parameters in the automatic enrolment system to average earnings growth. The ‘earnings trigger’ (above which people have to be automatically enrolled) is now 13% below the annual value of a full new state pension (£11,502), whereas on its introduction in 2012 it was 45% higher than the then annual value of a full basic state pension.
In addition, we think that a set of reforms could be brought in to limit affordability concerns resulting from higher pension contributions:
• Employees who face higher default pension contributions under our suggestions should be given the choice to ‘opt down’ to the minimum pension contribution rates currently in operation.

• If the government implements legislation passed in 2023 which would increase default contributions by basing them on earnings from the ‘first pound’, it should give serious consideration to diverting the additional contributions initially into a liquid savings account, similar to the NEST ‘sidecar’ account. This would help those with low – or no – liquid wealth for whom ‘rainy day’ saving may be more appropriate than pension saving. 

Overall, implementing these suggestions would boost retirement incomes by between 12% and 16% (£1,400 to £2,100 per year) for those currently on track for low and middle incomes in retirement. But it would only reduce the take-home pay of lower earners by a small amount (in all likelihood a less than 1% fall in take-home pay). This can happen because some of those on track for low retirement incomes will spend time as higher earners and so save more as a result of these changes. In comparison, moving to minimum 12% contributions would also boost retirement incomes but would generate considerably bigger falls in take-home pay for low-paid workers.

Laurence O’Brien, a Research Economist at IFS and an author of the report, said:
‘While the state pension now provides a strong foundation income in retirement, most will want or need to supplement that. Too many private sector employees appear on course to end up on a low – or disappointing – retirement income. While there is often concern about savers not saving enough, an additional problem is that despite automatic enrolment boosting workplace pension membership, more than one in five private sector employees are still not saving in a pension.’

David Sturrock, a Senior Research Economist at IFS and another author of the report, said: 
‘It is really important to take seriously the affordability of asking for bigger pension contributions from many low-earning individuals, as well as the need for many to save more. We suggest a way forward that would focus the encouragement of higher contributions on periods of life when people have average, or higher, earnings. Allowing people to opt down to lower contributions, or diverting some contributions into savings accounts, are also good options. There is a strong case for almost all employees to receive an employer pension contribution, irrespective of whether they make a contribution themselves. That would be a bigger change to the system – and one that would likely be of particular benefit to many low earners.’

Mubin Haq, Chief Executive of the abrdn Financial Fairness Trust, said:
‘Auto-enrolment has been a huge success, significantly increasing the numbers saving into a pension. However, there’s much more it could achieve, especially for low earners who are currently missing out from an employer paying into their pension pot. Guaranteeing 3% from the employer regardless of whether an employee makes a contribution could boost employer pension contributions by £4 billion per year. This would particularly benefit women, those working part-time, young adults and the low-paid.’

Read the Adequacy of future retirement incomes: new evidence for private sector employees report