Auto-enrolment: how and when should default contribution rates rise to 12%?

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A new framework outlines tests for determining the economic conditions that would allow for default contribution rates to increase. It also outlines tests that would necessitate a pause. 

At the moment, millions of workers are not on course for the retirement income they expect .

Increasing the default workplace pension contribution rate from 8% to 12% could change that. In fact, it’s the single biggest lever we have to pull to improve retirement outcomes.

But when should this increase take place? And what would be the process?

Now hardly seems the best time to introduce such an increase, with many households and businesses facing lots of financial pressures. But if we leave it too late, more people could be left facing financial insecurity in retirement.

Until now, there hasn’t been a mechanism for increasing default pension contributions that balances the interests of savers and the wider economy.

New research by Phoenix Group, our parent company, changes that.

Produced in partnership with WPI Economics, the research outlines a framework that helps policymakers to determine how and when default contributions rates should increase to 12%.  

This framework takes a pragmatic approach, putting in place safeguards to ensure that contribution increases are only triggered as the economy improves. We believe this can underpin a consensus-based approach to ensuring more people enjoy a decent retirement.

(For more details, see the report, Raising the bar: A framework for increasing auto enrolment contributions.)

Pragmatic tests

The framework outlines “tests” for determining the economic and financial conditions that would allow for default contribution rates to increase. It also outlines tests that would necessitate a pause. 

These tests can help to ensure that any future increases to contributions are sustainable and affordable.

These tests are as follows:

1. Start tests – when is the right time to start moving from 8% to 12%:
   • Auto-enrolment opt-out rates are not above a certain threshold (for example, 20%)
   • Real household disposable income per person (RHDIpp) has risen in one of the last two quarters
   • Job vacancies are between 2% and 3% of total employment
2. Handbrake tests – should increases be paused due to extreme wider economic conditions:
   • RHDIpp has fallen every quarter for a year
   • Job vacancies are above 3.5% or below 1.5% of total employment
3. Wider considerations: 
   • High overall employment costs, including those driven by, for example, employer’s national insurance contributions
   • Rising household debt among low-income households
   • Increased risk of over-saving by those on lower incomes

As part of this research, Standard Life – along with its parent company, Phoenix Group – is calling for a legislated annual review to assess whether auto-enrolment (AE) savings levels are achieving decent retirement outcomes. If savings levels are falling short, the review would assess whether contributions could be raised according to the criteria outlined above.

The yearly analysis should be carried out by the government. It should also involve engagement with representatives from employers, unions, personal finance charities and other groups with an interest in pension contributions.

AE has been a huge policy success, helping many more people to save for their future. However, millions of people are still not on track to meet their expected retirement income. 

It’s therefore vital we keep taking practical steps towards increasing default contribution rates. We hope this framework is the start of that journey.

 

For more details, see the report, Raising the bar: A framework for increasing auto enrolment contributions.