The IFS has called for auto-enrolment reforms, warning that a 1 per cent drop in pension returns could lead to over half of private sector workers undersaving, with 40 per cent missing the minimum retirement standard.
In its ‘Adequacy of future retirement incomes’ report, the IFS examines the prospects for UK employees’ retirement incomes, emphasising substantial changes and challenges since the Pensions Commission’s recommendations two decades ago.
The report highlights that while automatic enrolment has been successful, many employees are not saving enough to meet their retirement income targets. The IFS proposes reforms such as increasing pension contributions to 12 per cent of salary, requiring employers to contribute at least 3 per cent, and creating a “sidecar” savings plan for low-income individuals.
According to the report, employer pension contributions have been stable since 2005, although this has not completely closed the savings gap. The report found that higher-income individuals and private renters are more likely to have inadequate retirement assets. It also found that women are more likely to reach replacement rate targets, although they frequently fail to satisfy minimum wage requirements.
These challenges, including stagnant earnings growth, lower returns on savings, and longer life expectancy, mean workers must save 1-3 per cent more than initially expected to secure adequate retirement incomes.
Industry experts have responded to the the IFS’s recommendations, underlining the urgent need for increased contributions, better employer support, and new savings models to address the looming retirement income crisis.
PLSA chief policy counsel Nigel Peaple says: “There is broad consensus that UK savers are not saving enough for retirement. Only half of workers are on track to achieve the target income replacement rates put forward by the independent Pension Commission and a fifth will fall short of the Minimum amount needed for a liveable retirement as defined by the Retirement Living Standards.
“The PLSA has long argued for gradual increases in pension contributions, over the next decade, from the current 8 per cent of only a portion of earnings to 12 per cent of all salary, with employers paying more so that, by about 10 years from now, both employers and employees would pay the same.
“The IFS proposals provide some helpful ideas on this important topic such as increasing pension contributions to 12 per cent for most savers and considering ways to ensure contributions are affordable, if automatic contributions increase, by introducing an opt-down mechanism. We also agree Government should consider how to help people, especially on low incomes, make “emergency savings”, possibly in a side-car mechanism, although most savers will still also need to save extra for retirement.
“These issues should be considered as part of the Government’s planned second phase of its Pensions Review.”
Royal London director of policy Jamie Jenkins says: “The nation is facing up to a ticking time bomb, with increasing numbers of people heading towards retirement with inadequate savings. This isn’t simply a societal issue, but an economic challenge. People should be able to retire with dignity, rather than feel they enter later life viewed as a burden on the working population.
“The Government’s review of the pensions landscape is a crucial inflection point, and a rare opportunity to put us on a different trajectory; one that gives people confidence for the future and sets us on a more sustainable path for the economy over the long term. The Institute for Fiscal Studies has produced a thoughtful and well-researched package of recommendations which should be seriously considered as part of that review.”
Quilter head of retirement policy Jon Greer says: “Automatic enrolment has undoubtedly proved to be a huge success, bringing millions into the pension savings fold. However, as the IFS outlines, many are still simply not saving enough. In recent years, reforms have been challenging, given the cost-of-living crisis that has stretched finances in ways many had not experienced before.
“Auto-enrolment largely relies on people’s inertia, but significant financial pressures today may prompt individuals to reduce or stop pension funding altogether. Therefore, there is a fine balance to be struck with AE reform. We know that many in the UK are at risk of having inadequate savings to fund their desired lifestyle in retirement. This is particularly true for under-pensioned groups, such as the self-employed, who are less likely to have private pension savings to supplement their state pension.
“The IFS’s suggestion to ensure employees receive an employer pension contribution of at least 3% of total pay, irrespective of their own contributions, is worth consideration. This would benefit the 22% of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to low earnings. However, there is a risk that this could lead to more employees opting out of making their own contributions. A trial approach, as suggested by the IFS, could be a prudent way to assess the impact before full implementation.
“The IFS’s suggestion of using the pensions ‘sidecar’ model for lower earners is interesting and worth considering. There are slight risks of the sidecar proposal that are well known. Diverting some pension saving to a liquid account will impact the amount saved for retirement, but arguably offset by ensuring more people save long-term. It’s not clear that it would increase engagement and therefore some may not even know about the liquid sidecar that could be used as a rainy day fund, and those that do may be tempted to draw on the money other than for the intended purpose.
“Expanding the age range for automatic enrolment from 16 to 74 is another commendable suggestion. This would help more people in paid work save for later life, ensuring that younger workers start saving embedding long-term savings as a social norm earlier, and older workers continue to build their retirement funds.
“The IFS also proposes to increase default employee contributions for those on average incomes and above, while protecting lower earners. By targeting higher contributions on earnings above a certain threshold, such as £35,000, we can help middle and higher earners better supplement their state pension without unduly impacting those who can least afford it. However, there will be cohorts, such as those earners leaving university with large student loans, who may still feel this puts too much pressure on take home pay.
“Raising the upper limit on qualifying earnings, which has been frozen at £50,270 since 2021-22, is also a necessary reform. The real value of this limit has fallen significantly. Indexing key parameters in the automatic enrolment system to average earnings growth would futureproof the system and ensure it remains relevant and effective.
“While the IFS’s proposed reforms present a balanced approach to enhancing auto enrolment, it is crucial to consider the broader economic context and the potential impact on individuals’ financial behaviour.
“For anyone concerned about their level of saving for retirement, the best thing to do is start planning as early as possible. Think about the kind of income you want to achieve your desired standard of living and then work backwards by projecting how much you’ll need to reach that target and finding a way to save toward that long-term goal. Inheritance should be treated as a bonus.”