By Tom McPhail
Head of Pensions Research, Hargreaves Lansdown
Tom McPhail, Hargreaves Lansdown
Some economists have said we should be compelled to save for our retirement as a way to solve the UK pension crisis.
In advance of a major report into the UK pensions crisis, a financial expert explains how compelling people to save would work and what it offers to policymakers.
The general consensus is that unless we boost the level of UK savings, then large swathes of the population are going to find it hard to make ends meet in retirement.
According to the Office for National Statistics, the UK's savings rate is currently about 5% of household income.
It has been around this level for several years now. However it is worth noting that it has been a lot higher in the past.
The rate at which people save tends to work in the opposite direction to the economy in general; when times are good (as they have been, by and large, for a few years now) people spend rather than save; by contrast, when the UK suffered an economic depression back in the early 1980s, the savings rate was up around the 11% mark.
A good pension costs a lot of money.
The traditional final salary schemes, which pay out a (fairly) guaranteed pension of up to two thirds of members' final salaries, currently require contribution rates of 20% or more of members' earnings.
We have already arrived at a point where almost the only employers who can continue to offer these generous guarantees are the ones in the public sector whose promises are backed by general taxation.
In the private sector, more and more employers are moving across to money purchase pensions, where the benefits are not guaranteed, the investment risk is carried by the member, and the amounts being invested tend to be lower.
In contrast to final salary schemes, the average contribution rate to money purchase pensions tends to be in the range of 6% to 12%.
As a further complication to the problem, there are about 12 million adults in the UK who have no form of funded pension provision at all.
In this context, the option of compulsory savings looks like an obvious quick-fix solution: Force everyone to save more; job done.
So should the government simply accept that the voluntary system has failed, and instead go for a compulsory system?
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In spite of the fact that various surveys over the past year have suggested that this would not be an unpopular move, there is considerable political resistance to this idea.
For a start, some of these surveys are a little suspect, and may have been contrived to simply support the view of the sponsoring organisation.
More importantly, politicians don't like the idea of compelling people to save; it looks too much like a tax increase, and would leave them open to accusations of taking money out of voters' pockets at the next election.
There is also the problem that because of the complex interaction of state benefits and private savings, for some people, particularly low-earners, saving into a pension may actually not be in their interests.
Finally, If something goes wrong with a pension which people have been forced to save into, then they are apt to blame the government.
We have already seen this happen with final salary pensions which failed, with the result that the government has already had to allocate £400m to pay compensation to scheme members, with every chance that the final cost will be even higher.
There is also the fact that in Australia, where compulsion was introduced in the early 1990s, the savings rate actually fell, as everyone accepted the compulsory rate as the new benchmark, and reduced their savings accordingly.
In fact, it is only in the past few years that the savings rate in Australia has risen to a level where the policy could genuinely be regarded as a success
A more likely scenario involves creeping compulsion through the workplace.
The Department for Work & Pensions (DWP) has made much of the role employers have to play in dealing with pensions
Ministers have highlighted the proposition that employees should be automatically enrolled into a company pension, and then given the choice to opt out.
Given many people's natural inertia, the chances are that once in, they will stay in.
This is a good step; the problem though is that many employers don't contribute to their employees' pensions, despite the fact that they are required by law to offer membership.
So there isn't much sense in getting everyone into a pension, unless there is also some form of compulsory contribution.
Given that companies don't vote, people do, and that such a move would enjoy strong support form the likes of the TUC, a compulsory employer contribution, of perhaps 3% of payroll, looks like a more realistic starting place for any government which wants to start gently raising the bar.
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