House of Commons - Automatic enrolment in workplace pensions and the National Employment Savings Trust

Automatic enrolment in workplace pensions and the National Employment Savings Trust - Work and Pensions Committee Contents

2 Increasing participation in pension saving

Addressing the decline in retirement saving

14. The policy of automatic enrolment has been pursued by successive governments to address a concern that individuals are both living longer and not saving enough to enjoy an adequate income in retirement. In 2005, the Pensions Commission indicated that private pension saving was in "serious and probably irreversible decline". It found that employers' willingness voluntarily to provide pensions was falling and that initiatives to stimulate personal pension saving had not been successful. The Commission concluded that the current voluntary private funded system, combined with the current state system, was not fit for purpose for the future. It therefore recommended that employees should be automatically enrolled into workplace pension schemes and that the Government should reform the State Pension so that over time it became more generous and based on a flat rate but paid at a higher age.[13]

15. The Pensions Commission's concerns about private pension saving are supported by recent evidence from the DWP's Family Resources Survey. This research highlighted a gradual decline in private pension saving over the last 10 years, with a particular decrease among two demographic groups; men of all ages and people under 40. The survey found that in 2009-10 only 38% of working-age people—11.6 million out of 30.4 million people[14]— were saving into a private pension, compared with 46% in 1999-2000. Over the same period, pension saving among men fell from 52% to 39%, and among individuals aged between 20 and 39, from 43% to 31%.[15]

16. Separate DWP figures showed that, in 2010, over 11.5 million private sector jobs had no pension provision, an increase of 2.5 million since 1997. The Department estimated that seven million people were not saving enough to enjoy the security in retirement that they aspired to.[16] The latest survey from the Office for National Statistics showed that, in 2011, only 33% of private sector employees were members of a workplace pension scheme.[17] DWP indicated that this figure represented a fall from 46% in 1997.[18]

17. Having identified this serious deficit in retirement saving, the Pensions Commission concluded that people would be far more likely to enter a pension scheme if they were automatically enrolled with a right to opt out, than if they were required to make a positive choice to join a pension scheme. They described this model as adopting the "power of inertia" in order to achieve an increase in pension saving.[19]

18. We welcome the decision by successive governments to pursue auto-enrolment in order to address the steady decline in pension saving. The policy has been designed to encourage high levels of participation in workplace pension saving, whilst retaining an individual's freedom to opt out. The recommendations contained in our report are intended to support the successful implementation of auto-enrolment.

Estimated participation rates

19. According to DWP estimates, 9-10 million people will be eligible for automatic enrolment into a qualifying workplace pension scheme. DWP estimated that 2-4 million individuals would opt out of automatic enrolment, leaving 5-8 million individuals newly saving or saving more as a result of automatic enrolment.[20] DWP research found that 65% of respondents would "definitely" or "probably" stay enrolled, whilst 20% would "definitely" or "probably" opt out.[21]

20. Although the levels of participation and opt-out are difficult to predict, we believe that the Government's estimates are reasonable and broadly in line with other available evidence. Survey results published by the National Association of Pension Funds (NAPF) in October 2011 indicated that 27% of people thought it unlikely they would remain in auto-enrolment schemes, while 57% said it was likely and 16% were unsure. The NAPF suggested that a proportion of the "unsure" respondents might also opt out, and they concluded that overall one in three workers—around three million people—might opt out. Of those who told the NAPF's survey they would opt out, nearly 48% said they could not afford the contributions, 29% said they did not trust the Government and 26% said they did not trust the pensions industry. The NAPF believed that fears about fees and charges were a major obstacle to the success of auto-enrolment and the organisation is itself taking steps to develop an industry code of practice on the transparency of fees and charges.[22] We consider concerns relating to fees and charges in chapter 3 of this Report.

21. The Pensions Policy Institute (PPI) highlighted the complexities in estimating participation rates under auto-enrolment, given that this is a new policy with limited international comparisons. PPI suggested that a 20% opt-out rate would be an optimistic scenario; 33% would be in line with the central case made by the Government; and a 50-60% opt-out rate would be a pessimistic scenario. PPI indicated that the only international comparison is the KiwiSaver experience in New Zealand, which was launched in July 2007.[23]Under this scheme, workers aged 18-65 starting a new job are automatically enrolled in the KiwiSaver, but can opt out from day 14 to day 56 of their employment. The percentage of members who were enrolled into KiwiSaver automatically and chose to opt out has declined over the past three years from 34% for 2009 to 28% for 2011.[24] DWP has therefore estimated a slightly higher opt-out rate than the current rate in New Zealand.

22. However, there are some significant differences between the KiwiSaver and the UK's criteria for auto-enrolment, including some measures that may encourage higher participation rates in New Zealand. Individuals can only opt out of the KiwiSaver during the first eight weeks of being auto-enrolled, whereas UK employees can opt out at any time. In addition, in New Zealand, individuals can only have one pension account, whereas UK employees can establish a number of smaller pension pots.[25]

23. The New Zealand Government also introduced financial incentives for individuals to participate in the KiwiSaver scheme. When an individual joins KiwiSaver they receive a $1,000 tax-free "kick start" to their savings from the Government. They also receive a tax credit payment of up to $1,042.86 a year, and potentially a first-home deposit subsidy.[26] KiwiSaver members can also withdraw their savings (minus the Government contributions) to buy a first home or if experiencing financial hardship or serious illness.[27]The home ownership incentives became operational in July 2010, and an initial evaluation found that the number of KiwiSaver members receiving a first home withdrawal and/or being approved for a first home subsidy was higher than forecast.[28] This may suggest that these incentives are popular among savers in New Zealand, although the ability to withdraw funds would of course have implications in terms of overall retirement saving.

24. The UK model for auto-enrolment provides tax relief for scheme members on contributions. At this late stage of the implementation it would not be advisable for the Government to consider adding additional upfront financial incentives to encourage participation. However, following the implementation phase, the Government could consider the advantages and disadvantages of introducing the ability for individuals to withdraw savings, for example to help them buy a first home. The Minister indicated that the Government may look at this issue again in the future, especially if the inability to withdraw funds was found to be a significant influence on those deciding to opt out of auto-enrolment.[29]

25. Retirement saving through auto-enrolment may be even more attractive to individuals if it offered additional financial incentives or flexibilities. We welcome the Minister's willingness to look at this again. In its review of auto-enrolment scheduled for 2017, the Government should consider the advantages and disadvantages, including the legal implications, of enabling individuals to withdraw pension savings to buy a first home. The New Zealand experience may offer evidence on the extent to which savers' behaviour has been affected by this aspect of the KiwiSaver scheme.

Relationship between auto-enrolment and the State Pension

26. The Pensions Commission recommended that, in addition to the introduction of auto-enrolment, the Government should reform the State Pension so as to greatly reduce the prevalence of means-testing. They considered that this was essential in order to provide clear incentives to individuals who were considering pension saving but concerned that their private retirement income would be means-tested. The Commission also proposed that the State Pension should be uprated in line with earnings but that pension age should rise, resulting overall in an increase in expenditure as a percentage of GDP between 2020 and 2045.[30] In New Zealand, the Superannuation payments for those aged 65 and over are not income tested and are paid at a higher rate than the UK's Basic State Pension rate.[31]

27. The 2011 Green Paper A State Pension System for the 21st Century outlined the Government's belief that automatic enrolment would only succeed "if today's workers feel confident that it will be worth their while saving and if they understand how much they need to save to fund their aspirations for retirement". The Green Paper highlighted the complexity and uncertainty in the State Pension system, noting that many people are unsure what their State Pension will be worth when they retire. It also indicated that the current reliance on means-testing in the current system meant that incentives to save were not clear and that groups such as women and the low paid tended to have poorer State Pensions. The Government proposed two options to reform the State Pension:

Option 1: acceleration of existing reforms so that the State Pension evolves into a two-tier flat-rate structure more quickly; or
Option 2: more radical reform to a single-tier flat-rate pension set above the level of the Pension Credit standard minimum guarantee.[32]

28. Respondents to the Government's Green Paper consultation broadly supported option 2, with around three-quarters of organisations supporting a single tier pension in principle.[33] Many witnesses in our inquiry also supported the Government's proposal for a flat-rate State Pension, expressing concern that people would otherwise see their private pension savings effectively reduced by the loss of means-tested benefits in retirement. The Centre for Retirement Reform believed that the Government should move ahead with their proposals "so that everyone who saves in a pension scheme will be better off at retirement than those who don't save".[34] The Association of British Insurers (ABI) and NAPF both indicated that moving to a flat-rate, simple State Pension would reduce existing disincentives to save for retirement, and the NAPF also suggested that a single tier pension would make it easier for employers to make decisions about scheme benefits and contribution levels.[35]

29. Legal & General argued that the numbers opting out of auto-enrolment would be lower if the Government's proposals to reform the State Pension were in progress by the time employees start being auto-enrolled, as this would significantly reduce the fear that people would lose means-tested benefits as a result of increased retirement saving.[36] In addition, Aviva believed that the Government's proposals would help people understand the mix of state and private provision that they could expect on retirement, and therefore make informed plans for their retirement saving.[37]

30. The current State Pension system, with its means-tested Pension Credit top-ups, may act as a disincentive to some individuals on lower incomes who are considering workplace pension saving. The Government's plans to reform the State Pension and reduce means-testing are therefore welcome, and essential in creating a simpler foundation pension which will enable people to increase their retirement saving with confidence that they will not be penalised by losing state benefits.

31. The Government must set out its detailed plans for State Pension reform as a matter of urgency. Individuals need certainty on the Government's plans if they are to make informed decisions about their retirement saving and whether to remain enrolled in their workplace scheme. Equally, financial advisers need clarity about the future of the State Pension if they are to provide sound, long-term advice to individuals. We urge the Government to proceed with its reform of the State Pension without delay and to introduce its Bill on State Pension reform in the 2012-13 session of Parliament.

Minimum thresholds for employee eligibility

32. The self-employed and individuals with earnings between £5,715 and £7,475 will not be auto-enrolled into a pension scheme, although they will be able to opt in. We explored the implications for individuals earning below the £7,475 threshold, and in particular whether any particular groups on lower incomes may be disadvantaged as a result.

33. The 2010 Johnson review recommended that the earnings threshold for automatic enrolment should be aligned with the personal allowance for income tax and that the threshold from which pension contributions become payable should be aligned with the National Insurance primary threshold. The rationale was that lower earners would otherwise produce very small pension pots, undermining the credibility of the reforms.[38] Following the Johnson review, the Government subsequently raised the annual minimum earnings threshold from £5,035 to £7,475 to reflect these recommendations.

34. The review also estimated that increasing the threshold from £5,035 to £7,475 would mean that one million fewer people would be eligible for automatic enrolment (a 10% reduction), with a fall in total individuals contributions of £180 million (a 4% reduction). It also noted that costs for employers would be reduced.[39] The Pensions Policy Institute (PPI) indicated that part-time, temporary, casual and agency staff were likely to have lower earnings than full-time employees and might consequently fall under the threshold for eligibility.[40] Raising the threshold further, as proposed by the Government's consultation in December 2011, would reduce further the number of people eligible for auto-enrolment.[41]

35. The Coalition Government has stated its intention to increase the personal allowance for income tax to £10,000.[42] If the Government decides to align the minimum earnings threshold for auto-enrolment with the personal allowance (as recommended in the 2010 review), this would further reduce the number of employees eligible for auto-enrolment. The Minister suggested that excluding some lower earners from eligibility would not necessarily make a significant difference to their income on retirement:

The Johnson review offered a similar view, indicating that somebody earning £10,000 a year over a working life would, net of tax, be entitled to almost as much in benefits at retirement as they received in work.[44] This implies that raising the threshold may not be that damaging for lower earners.

36. However, the review decided against recommending a higher threshold of over £10,000. Firstly it argued that working tax credits provide a big incentive for many low earners to save in pensions. Under the current tax credit arrangements, 100% of an individual's workplace pension contributions can be disregarded in their income assessment (although from 2013 this will reduce to 50%). Secondly, the review concluded that most low earners go on to earn more at some point and can only accumulate a pot of reasonable value by saving year on year. It found that most very low earners were women living with men who were on higher incomes, and that it might be desirable for those women to accumulate a pension pot of their own.[45] Baroness Drake, a member of the Pensions Commission, was particularly concerned about how raising the income threshold might disadvantage women:

37. The Government's consultation on the first annual revision of the automatic enrolment earnings threshold closed in January 2012. It proposed options for relatively modest increases in the threshold, and did not propose lifting the threshold to £10,000 at this stage. The consultation outlined the potential implications for women, black and ethnic minorities, individuals with disabilities and younger workers, and highlighted that women would be significantly affected; if the threshold was raised to £8,105, some 90,000 people would become ineligible, of whom 75,000 would be women.[47] We await with interest the Government's response to the consultation.

38. We understand the complexities in setting a minimum income threshold for automatic enrolment and accept the rationale behind the current threshold levels. The case for increasing the income threshold significantly above its current level in real terms is not clear. As women have historically retired earlier, and had lower earnings and lower pensions than men, we believe that it is very welcome that auto-enrolment will bring so many millions of women into pensions saving for the first time. However, as women make up the majority of persistently lower earners, the Government needs to consider the impact on the gender pensions gap when setting the income threshold. We do not regard it as essential that there should be a permanent link between the auto-enrolment threshold and the income tax threshold.

Impact on existing workplace pension schemes

39. Witnesses raised concerns that some businesses may choose to reduce their existing pension provision to the statutory minimum for auto-enrolment in order to contain their costs (known as "levelling down"). The Institute for Fiscal Studies reported that, although automatically enrolling employees in a workplace pension could substantially raise participation rates, it could also lead some employees to save less than they would have done if their company had previously invited them to opt into a workplace pension scheme. Its report showed that, when large companies have switched to automatically enrolling staff, contributions rates tended to be lower than those previously offered under an opt-in system.[48] The NAPF's latest Annual Survey showed that 7% of its members were planning to level down in some way and 20% had not yet decided what they were going to do in the face of increasing costs.[49]

40. PPI indicated that in an optimistic scenario, in which all employers auto-enrol their qualifying employees under existing terms, total annual pension contributions in the UK could be £10 billion (in 2006-07 earnings terms) higher than without the reforms by 2050. By contrast, in PPI's most pessimistic scenario in which all employers make only the minimum contribution of 3% of band earnings, total annual pension contributions could actually be £10 billion lower than without the reforms by 2050 (again in 2006-07 earnings terms).[50]

41. The Minister suggested that, while some firms may level down, they would be unlikely to take their current scheme and "make it worse" for existing scheme members on the grounds that: "Saying to your existing work force who are in a good scheme, 'Guess what, guys, we are going to cut your pension,' is a heck of a difficult conversation."[51] He also indicated that auto-enrolment was designed principally to support employees who currently have no workplace pension scheme:

Baroness Drake shared this view:

Niki Cleal of the PPI highlighted that around 10% of private sector companies offer a pension contribution of over 3% of an individual's salary. However, since these companies tend to be larger employers they incorporate around 50% of existing workplace pension members. She suggested that, while there may be some levelling down among these employers, it was important to remember the 60% of private sector employees with no workplace pension.[54]

42. We recognise the risk that some employers may level down their existing pension provision to the statutory minimum for auto-enrolment, although it is very difficult to assess the extent to which this might take place in practice. However, the risk that some employers may level down their contributions is outweighed by the strong likelihood that auto-enrolment will introduce millions of individuals to pension saving for the first time.

Encouraging contributions above the minimum rate

43. The Pensions Commission recommended that the Government should strongly encourage median earners to achieve an income in retirement that represents around 45-50% of what they earned during their working life (known as the "replacement rate"). However, the Commission found that many individuals actually aspired to a replacement rate of up to 67% and further recommended that Government policy should enable additional saving at low cost so that people could reach that level.[55] Figures published by the Organisation for Economic Cooperation and Development showed that the UK State Pension provided a median earner with a replacement rate of 37%.[56] Even without the reform of the State Pension, as discussed earlier in this chapter, auto-enrolment is therefore expected to play a pivotal role in helping individuals reach their desired income in retirement."

44. The combined minimum rate of employer and employee contributions (including tax relief) for auto-enrolment when fully implemented will be 8%. When he gave evidence in March 2011, the Minister noted that "8% is not going to get you much of a pension, particularly if you start later in life, so obviously we will be encouraging people to start earlier, and our language will very much be that 8% is the floor not the norm."[57]

45. Niki Cleal made a similar point, arguing that the standard 8% contribution under auto-enrolment would not provide a sufficient retirement income for employees. However, she recognised that it was a "step forward" and would mean that "people, for the first time, will be accruing some kind of pension in their own right".[58] In New Zealand, employees and employers tended to contribute at the legal minimum rate for the KiwiSaver programme, which was also considered insufficient for some employees to achieve their desired income on retirement.[59]

46. The Investment Management Association also believed that an 8% contribution would not be sufficient, but they did not recommend raising this contribution rate in the near future:

47. Friends Life also called for an examination in 2017 of whether 8% of qualifying earnings would be sufficient to meet most employees' requirements in retirement. They proposed that employees could potentially be required to save more through gradually increasing employee and employer contribution by 1% every 2-3 years, as is the case in Australia.[61]

48. The minimum contribution rate of 8% is an important and realistic starting point for auto-enrolment. During the implementation stage, it is sensible for the Government to encourage participation in pension saving by increasing individual and employer contributions gradually to this moderate minimum level.

49. However, it is unlikely that 8% will secure a level of retirement provision which most employees would consider adequate. The Government should therefore conduct a review to examine a) how to promote saving above the 8% minimum; and b) whether it should raise the statutory minimum above 8% over the longer term. This review should take place by 2014, building on the lessons learned from implementation up to that point. Waiting until the review scheduled for 2017 to consider these issues could mean that many employees miss out on higher pension contributions for a longer period.

13 The Pensions Commission (2005), A New Pension Settlement for the Twenty-First Century Back

14 Figures based on a working age population of 30.4 million people according to DWP: www.dwp.gov.uk Back

15 Department for Work and Pensions (2011), Family Resources Survey: Estimates of Private Pension Participation Rates 1999/00 - 2009/10 Back

16 Ev 136 Back

17 Office for National Statistics (2012), 2011 Annual Survey of Hours and Earnings: Summary of Pension Results Back

18 Ev 136 Back

19 The Pensions Commission (2005), A New Pension Settlement for the Twenty-First Century Back

20 Department for Work and Pensions (2011), Pensions Act 2011 - Impacts - Annex B: Workplace Pension Reform Back

21 Ev 145 Back

22 National Association of Pension Funds (October 2011), Three million set to drop out of pensions auto-enrolment, www.napf.co.uk Back

23 Ev 116 Back

24 New Zealand Inland Revenue (2011), KiwiSaver evaluation. Annual report: July 2010 to June 2011 Back