Should the govt introduce mandatory contribution rates?
At a glance
- High mandatory contribution rates would ensure members have decent retirement pots
- However, it would be too difficult to implement as AE is still in its early days
- The UK could explore Australia’s employer compulsion laws as an option
Mandatory rates rather than minimum rates could substantially benefit members, but it may be too challenging to implement them now, writes Kim Kaveh.
Automatic enrolment (AE) has been rolling out for more than five years now, and has brought over eight million into a workplace pension.
While the government initiative is on track to reach its target to extend this to 10 million by next year, coverage is only part of AE's success.
It is also important for the government to reconsider the current contribution rate laws to ensure members are saving enough for retirement.
As it stands, the minimum contribution rate is 2%, of which at least 1% must be paid by the employer. By 2019 this will increase to a total of 8% of which at least 3% will have to be paid by the employer, but there are concerns this is still not enough to provide members with adequate pensions.
Mandatory rates
It could be argued the government should consider introducing higher mandatory contribution rates rather than setting a minimum rate.
Indeed, a recent Blackrock survey of more than 500 members of defined contribution (DC) schemes found seven in 10 savers were in favour of mandatory rates, as many were confused about how much they should be saving.
Doing this would mean employers and employees paying in a set amount from their earnings into their pension as decided by the government, but the member would still have the choice to opt out.
Trade Union Congress policy officer Tim Sharp says it is understandable members would want mandatory contribution rates.
"I think it's absurd we have a minimum contribution rate, and expect it to give them a good outcome. It's not going to do so, and there's evidently work to be done."
Former pensions minister baroness Ros Altmann thinks mandatory rates could mean everyone would end up with some kind of adequate pension saving, and that it would avoid the ‘should I, shouldn't I' conundrum, where members are unsure as to how much they need to save.
"Ultimately, you would need to include everyone in this, not just people earning over £10, 000," she adds.
Only workers earning more than £10,000 - and aged between 22 and state pension age are eligible for AE.
Challenges
There are clearly advantages of introducing mandatory contributions, but only if they were high enough to result in a decent pot of money at retirement. One of the challenges is deciding on what the ideal rate should be.
BlackRock believes it should be scaled towards 15%. It estimates a 30-year-old earning £30,000 and wanting roughly two thirds (£21,000) of their salary in retirement would have to contribute 10% of their monthly salary. However, if the same person waited until age 35, they would need to contribute 14% to achieve the same result, rising to 19% if they delayed until age 40.
Sharp believes mandatory levels should rest between 12% and 15%, but says "there has to be proper work done to know what the appropriate rate should be first."
However, this would be very difficult to decide as members are at different stages of retirement savings.
Legal and General Investment Management head of DC client solutions Simon Chinnery agrees.
"I get why intellectually, you could say it's nice and simple, everybody just contribute more, but it could result in real problems."
In addition, such mandatory rates would be very difficult for the government to introduce at this moment in time while AE is still in its early days.
Chinnery thinks there should be "some urgency injected into this process as there is a real danger policymakers thinking, ‘oh look job done we've got to 8%,' and then it drops to the bottom of the political agenda."
Once AE has rolled out to a minimum level, sooner or later the government is likely to introduce mandatory contributions, adds Altmann. "I think it will be considered around 2020, that's when it makes sense - but we need to start a conversation, and help people understand it."
Look to Australia
How could it work in practice? One option is to have a mandatory rate that the employer pays into a member's pension, taking the example of Australia's superannuation system.
Its mandatory employer contribution rate has been 9.5% since 1 July 2014, and based on revised laws will increase to 10% from July 2021, and 12% from July 2025.
Members are also encouraged to supplement this with voluntary contributions, if they wish.
Sharp says: "In Australia, this all happened over time and as a result they have a huge pot of retirement savings.
"We should be doing something like this and it's a real mistake to wait until we've got to 8%, as it may be too late."
However, Chinnery argues the Australians did it in a particularly "shock and awe" way, but got away with it.
"For the UK, adopting this system would now be premature, partly because of the good that is coming out of AE."
Introducing high mandatory contributions seems a good idea on the surface, but it is clear to see this would be too difficult to implement for the time being.
However, in future, when AE matures and minimum contributions reach a more adequate level, it would be a shame for the government to not consider such an initiative if it would lead to better retirement outcomes for members.
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