The auto-enrolment revolution rolls on with the recent announcement by the Department of Work and Pensions that 900,000 more people will have a work place pension following the entry into the scheme of those aged 18 to 21 years old.
However, the debate about how to ensure that more people can pay for their retirement is now moving on to the next stage. It’s good to know that more of us are currently contributing to our pensions but how do we make sure that we’re paying in enough and how should we ensure that we don’t just save but save more as we get nearer to retirement?
Auto-escalation, as the name suggests, means that the amount that employees pay into their pensions rises automatically, usually as an increase in the percentage of their salary and it’s often matched by their employer. This might typically be one per cent more each year with a cap after a certain number of years.
The idea of auto-escalation is that it overcomes an understandable inertia that most people experience when it comes to increasing their pension contributions. After all, only the most financially responsible of us are really likely, when we’re deciding what to spend our hard earned cash on, to devote more of it towards our pension.
With auto-escalation, ideally as your salary increases over the years, the extra one per cent or so that you pay out annually to your pension has less of an impact on your disposable income. Meanwhile, as your salary increases that every extra one per cent represents a larger sum going into your pension pot.
Auto-enrolment already features an element of auto-escalation because of the gradual increase to a total contribution rate of eight per cent in 2019. This will involve three per cent from the employer and five per cent from the employee. However, full auto-escalation would mean that the minimum contribution rises above this.
Former pensions minister Steve Webb is among those calling for auto-escalation to be made a priority. In April 2016, another former pensions minister, Ros Altmann, told delegates to the Pensions Management Institute (PMI) annual conference that after auto-enrolment is completed in 2019 the expectation is that the government will focus on auto-escalation.
While the UK might be moving slowly towards putting pressure on firms and employees to opt for auto-escalation, in the United States it’s much more advanced. Over half (58 per cent) of Fortune 100 companies with auto-enrolment also use auto-escalation, according to a recent survey. Among American employers making auto-escalation the default position according to employees’ terms of employment and requiring them to opt out has been reasonably successful in encouraging people to contribute more.
However, with pressure on profits and salaries both firms and their staff are likely to feel that every spare penny should go on more immediate priorities. Yet saving enough for retirement plus care costs is, of course, essential.
As always, awareness and knowledge among savers is the key here. Allowing us to see projections of our income at retirement, calculated using the recognised Pension Commission targets, helps us to understand how and when we’ll have to increase our contributions. These personal statements also allow an employer to calculate how much it will cost them to match these increased contributions.
Whatever the government decides to do, opting for some kind of auto-escalation, even at an informal level, should feature pretty high on any employee’s list of financial new year’s resolutions.
The best time to consider introducing auto-escalation is usually around the time of the annual salary review and, where appropriate, when bonus payments are calculated. It’s obviously important to get buy-in from the employee before auto-escalation is introduced, especially since, in many cases this will involve changing the terms of a contract of employment.
There’s a debate among pensions experts and employment lawyers about whether the government should change employment law to allow companies to amend existing employee contracts to include a higher contribution rate.
Some experts argue that the government should legislate to make auto-escalation the default rather than simply leaving it to employers to make the decision. Steve Webb has argued that the government must act because, as he puts it: “Firms are not going to do it unless they’re told to.”
In its response to the 2017 Automatic Enrolment Review the Association of British Insurers (ABI) said: “We believe it is correct to focus activity on encouraging individuals to save more than eight per cent and focus on more flexible ways to implement auto-escalation.”
It’s important to put auto-escalation into a wider retirement income context. Increasing the amount that you put into your pension pot is sensible but knowing what your goals are and understanding options open to you along with their various risks and returns is essential.
Generally, though, some form of auto-escalation, however informal, is a useful savings tool and, like a tough work out at the gym, increasing your pensions contributions automatically might hurt a bit at the time – but you’ll almost certainly feel the benefit afterwards.