The introduction of auto-enrolment means that educating people about the value of pensions is increasingly important if they are to make the right savings decisions
The shift from defined benefit (DB) to defined contribution (DC) pension schemes appears to be irreversible, but what does it mean for employers and their staff?
Funding a DB pension can cost more than 20 per cent of salary, whereas DC scheme contributions are often less than half this amount, so DC is usually much cheaper for employers. It also allows them to focus on their core business rather than being “a pension company that runs a business on the side”.
But for employees, the boot’s on the other foot. Not only might they receive a much smaller pension, but the onus is on them to ensure that they’re paying sufficient contributions and their fund is invested appropriately for their age and appetite for risk.
Auto-enrolment begins in October. How can the industry make it work?
By 2017 up to 8m new employees will be automatically enrolled into company pension schemes and the challenge will be persuading them to stay.
With tax relief enhancing the amount that employees pay, and employer contributions of at least 3 per cent of band earnings, auto-enrolment is a good deal for most workers. But we also need to educate people about the real value of long-term saving.
How can this be done?
We outline three scenarios in our report, Keep on Nudging. If someone on a salary of, say £25,000, retired today on little more than the state pension their income would drop to around 30 per cent of the income they were used to while working – just enough to live on really.
Over time, however, savings as a result of auto-enrolment could push this up to 45 per cent, enough for a couple of holidays a year and a new car now and then.
Our third scenario assumes some additional provision has been made, either by saving over and above the pension into an ISA or by paying higher pension contributions that automatically increase over time. Then retirement income could be 60 per cent of final salary: enough to live a much more rounded lifestyle.
How should auto-enrolment funds be invested?
Even today, more than 80 per cent of members use the scheme default funds and make no investment decisions at all.
Auto-enrolment will likely push this even higher, so providers, employers and their advisers will want to ensure the default options are appropriate. Standard Life has launched a new investment proposition designed to cater for different risk appetites. It provides future-proofed investment strategies to protect members’ funds from market volatility as they approach retirement.
What’s your view of new providers such as the government’s National Employment Savings Trust (NEST) entering the market?
We’re supportive. We’re working with NES T to create a proposition where some employees will use a Standard Life pension and others, NES T, so there will be co-operation as well as competition.
Pensions minister, Steve Webb, is proposing a number of changes to support auto-enrolment. What’s your view?
These include consolidating small pensions pots (so someone who changes employer 20 times doesn’t have 20 tiny pension schemes), and abolishing short-service refunds (where workers who don’t stay long in a job can have their contributions refunded when they leave). They’re well intentioned but they’re not without practical difficulties, and the industry is working hard to resolve these.
Jamie Jenkins is head of workplace strategy at Standard Life
Keep on Nudging, Standard Life’s research report on auto-enrolment is available at www.standardlife.com/static/docs/2011/reports/keep_on_nudging.pdf