Wealth Planning in focus
Success by default
Atticus Kidd, Wealth Planning Assistant
Andrew Rees, Illustration
Atticus Kidd, Wealth Planning Assistant at JM Finn, explores how the success of the auto enrolment initiative can be attributed to the core principles of behavioural science.
In 2012 we saw the launch of auto enrolment pensions in the UK. You have likely heard of the scheme and may have a workplace pension as a consequence. However, this is not a new concept; financial innovators Australia, who lead the world in contactless payment and have discarded copper coins, adopted the idea two decades prior and have watched the initiative’s success ripple around Europe.
The initiative works by changing the default scenario from having to set up a pension, into one where you automatically receive a pension but are given the option to opt-out. This resolved an age-old issue for policymakers struggling to convince the population to save more, despite £20 billion per annum in subsidies set aside to entice willing savers.
The scheme has attracted over 10 million extra savers for retirement in the UK since its inception, and statistics from the Department for Work and Pensions show that eligible private sector workers participating in their workplace pension have increased from 42% to 81% from 2012 to 2018 and opt-out levels have remained consistently low at around 9%.
Eligible private sector workers participating in their workplace pension increased from 42% to 81% from 2012 to 2018.
This is no surprise to those familiar with the theory behind auto enrolment that has enabled it to achieve so much. The initiative uses the principles of behavioural science and the research surrounding default options. In complex situations such as pension planning there can be friction surrounding decision making as you are asked to contemplate future scenarios with multiple variables. This requires a great deal of thought and conscious contemplation. Behavioural scientists instead want to appeal to the instinctual part of our psyche. Most of us are aware that saving into pensions is something we would like to be doing, we may not be aware of how best to achieve our retirement objectives but we can instinctively say that this is something the majority of us believe we should be doing. By changing the default question to ‘would you like to remain in a pension scheme?’ rather than ‘how would you like to save for retirement?’ the process becomes immensely simplified.
Unfortunately, despite all of its successes there are still some issues with auto enrolment pensions. Areas as complex as pensions rarely have one-size-fits-all solutions. We must then look at ways to tailor pensions to ensure that they fit retirement objectives. Currently there are three core issues surrounding auto enrolment pensions.
People not saving enough
Although the government has hiked minimum contributions up to a combined 8% from employee and employer this is not an indication of the optimal amount required to retire comfortably. Pensions experts have in fact indicated that total pension contributions would need to start at the 12% level before you could begin to see a meaningful impact on savings towards retirement.
The majority make the maximum contributions that their employer will match with little thought given to whether this is a sufficient amount to achieve any given objective.
Which? recently completed a survey on more than 6,000 real retirees. They found that to enjoy a comfortable retirement with a reasonable level of luxury (including long- haul trips and a new car every 5 years) requires £39,000 per annum. To achieve this Which? estimate you would need a minimum retirement pot of £455,500. A 20 year old would need to save £572 a month to achieve such a pot and a 50 year old would be looking at monthly contributions of £1,741. This is assuming basic rate tax relief, state pension and growth of 3% a year after charges.
To enjoy a comfortable retirement with a reasonable level of luxury requires £39,000 per annum.
One problem in making pension contributions can be affordability. Behavioural economists at the University of Chicago and University of California have found a solution for this problem which they have named ‘Save More TomorrowTM’. This involves committing a portion of future salary increases, in advance, towards retirement savings. We often live within our means and once those means expand, so too does our lifestyle. The scheme allows you to maintain moderate increases to your lifestyle whilst helping you to achieve a comfortable retirement. Those participating found that over 40 months their average savings rates had increased from 3.5% to 13.6%.
People saving but not engaging
Although a great deal are aware that they have a workplace pension, only a fraction know the features of their pension schemes.
Two areas to look at are investments, ensuring they match your attitude and capacity for risk, and nominated beneficiaries. The latter are those you elect to receive your pension when you die. Making sure your family are sufficiently provided for in the event of death is a popular overall objective within financial planning and is an easy way of ensuring tax efficient assets are passed on to loved ones. It is important to regularly update nominated beneficiaries to reflect your objectives.
Lifestyle funds can also present an issue. These are investments that de-risk themselves over time eventually moving entirely into low risk assets at your intended retirement date. However, if you have the incorrect intended retirement date or the fund simply does not match your retirement objectives then this can have negative consequences for the growth of your pension pot.
You may also accumulate multiple pensions over your working life. With all of these schemes typically working towards the same objective there may be benefits to consolidation, such as cost savings or simplification. Most pension schemes will facilitate transfers in but before proceeding you should ensure that the recipient contract is suitable for your retirement needs and that no guarantees are forgone by transferring.
Individuals who still remain under-saved
Unfortunately there are still a number of people who remain illegible for automatic enrolment. The government is taking steps to increase involvement by reducing the age cap from 22 to 18 and eliminating the lower earnings limit of £10,000. However, these measures are not due to be implemented until mid-2020.
The principal group left unaffected by auto enrolment are the self-employed. Due to the typically irregular nature of income it can be tricky to establish a consistent and affordable level of pension contributions. Fortunately there are a number of freedoms and flexibilities afforded to the self-employed that allow alternative avenues to be explored. Retirement saving amongst the self-employed remains low but, auto enrolment would serve as a restriction compared to the solutions currently available so research into this area should be considered.
In conclusion, auto enrolment is a fantastic initiative and one that should be praised for its success. However, there still needs to be more active involvement in order to ensure that pensions can adequately provide a comfortable retirement.
The information provided in this article is of a general nature. It is not a substitute for specific advice with regard to your own circumstances. You are recommended to obtain professional advice from a professional accountant or solicitor before you take any action or refrain from action.
To meet one of our Chartered Financial Planners to discuss tax and estate planning, please contact your investment manager who will be happy to arrange a meeting.