Nationwide’s success story provides two vital lessons for raising auto-enrolment contribution levels
Contribution rates have been the big casualty of auto-enrolment. As the numbers paying into a pension scheme have soared, the amount each member saves has plummeted. The average contribution to a DC scheme (employer and employee combined) was just 4% in 2015.
It shouldn’t need saying that this is not enough to provide a decent retirement income. Even with statutory minimum contributions set to rise to 8%, the PLSA has calculated that more than half of today’s workers are at risk of falling short of a good replacement rate.
So the most important task for those charged by the government with reviewing auto-enrolment is to find ways to increase contribution rates. The PLSA says minimum rates should rise to at least 12%, while the Pensions Institute’s David Blake thinks we should target 15%.
But how should we get there? Auto-escalation is often touted as the solution – if contributions are gently increased each time a saver gets a pay rise they will eventually – and painlessly – reach a decent saving rate.
But an exercise carried out by Nationwide suggests the government should take a different tack. By simply setting members’ default contribution rates at the level required to get the maximum employer match they significantly boosted employee contributions. Although they had the chance to opt down, the percentage of members paying in more than the ‘core’ 4% shot up from 9% to 84%.
This success has brought some attention, with former pensions minister Steve Webb suggesting it could provide a good model for raising saving rates.
So rather than raising the minimum contribution rate, the auto-enrolment review should look at raising default contributions, first to 12%, then to 16%, while allowing members to opt down to 8%.
But there is one element of Nationwide’s approach that cannot be ignored. The employer offers very generous contributions by DC standards. Its core employer contribution is 13%, and staff paying in a total of 7% of salary will get 16% from the company (remarkably similar to the 16.2% average employer contribution to DB schemes in 2015).
To keep opt outs and opt downs low, it’s important that employers are made to pull their weight. The 8% minimum contribution planned for 2019 is split 3% employer, 4% employee and 1% tax relief. A default 16% contribution split 8% employer, 6% employee and 2% tax relief would go a long way to making sure tomorrow’s workers can afford to retire.