By changing the default from opt-in to opt-out, automatic enrolment is successfully reversing the long-term decline in the number of people saving into workplace pensions in the UK. Opt-out rates have been between 8 and 14 per cent, rather than the 28 per cent the Department for Work and Pensions originally estimated, though very much in line with early results on 401k defaults in the USA. Now that we can safely say that automatic enrolment in the UK is a success in terms of numbers of savers, with 6.1 million workers automatically enrolled as of March this year, we should turn our full attention to examining how the default is designed to make sure it is working for those enrolled in the long term.
One of the strongest forces in human behaviour is inertia; in many cases, consumers will maintain a default, even where there are benefits to straying from that default. This phenomenon has helped enrol people into workplace pensions, but it also means the vast majority of people enrolled are likely to stick with the default minimum contributions set by the scheme. By 2019 the minimum contribution is due to rise to 8 per cent of qualifying earnings, a figure much lower than the 15 per cent figure recently suggested as a target by The Independent Review of Retirement Income (IRRI). Research has found that people tend to infer that the default is an implicit recommendation, especially when the messenger is credible (such as the UK Government). By keeping the minimum contribution levels low, we risk encouraging people to under-save for their retirement.
Default savings contributions may not only need to be made larger, but also smarter. For example, one promising adaptation would be to allow savers to start with lower contributions, but with increases in contributions when they get a pay rise, in line with the Save More Tomorrow scheme.
People on lower incomes generally not only have proportionately less income to spare for saving, but also lack a financial cushion in case of emergencies. This lack of a financial cushion makes them much more vulnerable to financial shocks (e.g., inability to fix a broken car leading to job loss), and also – recent research suggests – acts as ‘mental tax’ that undermines effective decision-making. This creates a strong case for incorporating a ‘rainy day’ saving element into current pension arrangements, in effect allowing emergency withdrawals up to a certain limit. Such rainy day saving might come in the form of a blended product, taking advantage of the new “Help to Save” incentives for regular saving proposed in the last budget combined with the power of defaults built into employee pensions. Such adaptations could have transformative effects: between a quarter and half the UK population lack a sufficient financial cushion to withstand a financial shock of £1,500, and half a million households a year could be prevented from falling into problem debt by if they built £1,000 in precautionary savings.
As the Treasury develop the “Help to Save” scheme for launch in 2018, it will be vital for industry to come forward with innovative delivery models that help low-income groups to save, both for the long term and the short term.
A version of this blog post was published in the Pensions Policy Institute’s Future Book.