In our Organisation for Economic Co-operation and Development (OECD) paper published in 2019, The Investing and Saving Alliance reported that the that the UK mandatory state pension system had the lowest net replacement rate (NPR)* out of the 36 countries measured, with a rate of 28.4% of net average earnings.
Looking at the latest set of data published in 2021, the NPR for UK mandatory pensions has risen significantly, in fact, over doubled to 58.1% which places us 21st out of the 38 OECD countries measured. Given that average earnings for 2021 have increased from the 2019 statistics, how could the NPR more than doubled in two years?
If you delve into the lower-level detail, you will find that the OECD have now reclassified auto-enrolment (AE) from being a ‘voluntary' scheme to a ‘quasi-mandatory' scheme, due to over 85% of eligible employees participating - 88% in fact. If you include the then classified ‘voluntary' AE scheme to the 2019 data, the total NPR was 61%, so it has, in fact, slipped slightly.
Reclassification in 2021 has significantly impacted on figures but is this creating a misleading headline?
Going back to the reclassification, is it right for AE to be classed as quasi-mandatory? Based on the definition and membership rate, yes. But the two key words here are ‘eligible employees' and what that equates to in terms of the wider working age population. For instance, Turkey has a mandatory pension scheme which covers certain employees and membership only translates to 1.5% of the working age population.
Comparisons to the UK AE framework are difficult, however, coverage in 2021 was still less than half of the working age population, so to include AE as a mandatory pension system seems misleading. Given that other quasi-mandatory schemes achieve much higher coverage - up to 90% of the working age population - it would seem more appropriate for the definition to measure coverage against all employees or the total working age population.
While it is not possible from the statistics to separate out the NPR between state pension and AE, you can with the gross replacement rate (GPR). From the 35 countries which have a quoted percentage of average gross earnings, UK lies in 32nd place with a GPR of 21.6%.
This does not consider the wider state benefit packages that countries offer; however, it does highlight how UK pension systems compare to our OECD counterparts. Given that we are now firmly in a cost of living crisis which is predicted to worsen this year, the role of the state pension has arguably never been more important for pensioners and those approaching retirement.
If the UK is to continue in its progression to offer a truly world-class pension system, the triple lock must be honoured for future years to ensure pensioners are no worse off in real terms. We need to improve our standing with our OECD counterparts - the triple lock alone will not achieve this.
For nearly half of the working age population, retirement outcomes are heavily reliant on AE. All reviews and changes to the state pension must take in to account the overall retirement income targets that are deemed appropriate and the impacts this has on AE's ability to deliver on the income level that will be required from individuals' own pension provision.
Linking in with AE, the cost of living crisis - the likes of which has not been experienced for decades - with an expectation this will worsen later this year. Many households are facing tough decisions on meeting the rising costs of living and managing debt. Even those higher income households are likely to be impacted to a degree, with any regular savings potentially needing to be scaled back.
There are many factors to consider and households will have different priorities based on their individual circumstance. It is important that decisions are made on an informed basis with consideration given to the longer-term impact. This is particularly pertinent to workplace pension saving within the AE framework. If contributions are being made above the minimum level, it is important to understand whether any reduction impacts on the corresponding employer contribution. Many schemes operate on a matched basis, so it may not only be the personal contribution that reduces. For those already on the minimum level, opting out will mean that the benefit of the employer contribution is lost, so this needs careful consideration. The longer the period of opt out, the larger the impact this will have on retirement outcomes and the greater the level of contribution required to bridge the shortfall. Ultimately, this may mean working for longer or accepting a lower standard of living in retirement.
For some, there may simply be no other option but to reduce pension contributions or opt out in the short-term but it is important that it is made on an informed basis. For those who save into several products, then arguably the pension should be the last on the list for the reasons mentioned above.
For those who have reached minimum retirement age, there may be a temptation to access funds early to cover increased costs and for those who have already accessed their pension, to draw down more. Again, these may have significant impacts on future lifestyles and the potential ramifications need to be fully understood.
Given that circumstances are very personal and come in all shapes and sizes, this highlights the importance of seeking advice or guidance before making any decisions of this nature.
Renny Biggins is head of retirement at The Investing and Saving Alliance
*The net replacement rate is defined as the individual net pension entitlement divided by net pre-retirement earnings, taking account of personal income taxes and social security contributions paid by workers and pensioners.
