Before recommending changes to an auto-enrolment regime that has not even been fully implemented, says Bob Champion, policymakers need to consider the world of 2032 – not 2017.
This year the government will review auto-enrolment – and that is even before the original plans have been fully implemented. In the lead-up to the review, many organisations and commentators are already saying what they want it to deliver.
Any changes that come from the review will, however, take more than five years to implement and another 10 before they have any noticeable impact. As a result, policymakers need to consider the world of 2032, not 2017, before recommending changes.
Before we reach the 8% minimum contribution rate, the most popular call for change is for that rate to be increased to 12%. Let’s not forget that people have the freedom to opt out of auto-enrolment and my immediate concern is there must be a point at which individuals reach an affordability resistance level.
This may not be based upon a mathematical affordability – part of the resistance will be determined by the emotional loss of not having that money available to spend.
These resistance levels have not been tested. Those on lower incomes will be expected to have a lower resistance level, which could lead to an increasing number of opt-outs among those auto-enrolment was designed to help most.
In 2004, the Pension Commission, with the aid of the Pension Policy Institute, produced a table of target replacement retirement income ratios. These targets were calculated with the aim of delivering a lifetime income in retirement with the same standard of living as enjoyed while working.
But – and I am stating the obvious here – a lot has changed since 2004, namely:
* Longevity has continued to improve.
* As a result of the financial crisis, we have gone through an extended period of low inflation and investment returns.
* The default retirement age has been abolished.
* Pension freedoms have been introduced.
If everything else remained static, the first two points above easily lead to a conclusion that contribution rates should increase. Alas, everything else has not remained static. Neither will they – nor have we even seen the changes that will result from the Crickland State Pension Age review.
What is more there are other matters to consider, namely:
* The age at which people begin to move into retirement is increasing.
* How people retire is changing – for example, more than 12% of males over 65 have some form of employment income.
* A growing number of individuals are reaching the age at which they retire with a mortgage and other debt still outstanding.
* Technology advances are rapidly changing the workplace and working practices.
In my view, we should be trying to answer questions such as – how and when will retirement occur in 2032? What will be the spending patterns in retirement?
A longitudinal study of retirees in the US found almost a quarter were spending more than 120% of their pre-retirement spending six years into their retirement. We are familiar with u-shaped or ‘smiley face’ spending curves. Every individual is different, however, and we do not understand what influences particular individuals to spend.
Why people choose equity release
Maybe a clue to developing this understanding can be found in the reasons why people turn to equity release products. Among the most common reasons are to pay off loans and credit card debts followed by the need to finance regular bills. The most common reason of all is for home and/or garden improvements.
Many of the home improvements result from a previous overzealous decision to downsize. What we do not know is how many downsizing decisions were undertaken to help finance retirement spending.
In the early years of retirement, a healthy active individual is going to find it difficult to reduce their spending habits unless they have many inexpensive leisure pursuits. Faced with more leisure time, it is not unreasonable to expect spending to increase.
It is too soon to draw conclusions from what dictates pension saving withdrawals in the post-pension freedom world. In the pre-freedom days, some used their tax-free lump sum and, when that had gone, carried on spending as before, adding to their credit card debt until they reached a crunch point. Pension freedoms enable such spending to continue longer but the pension savings will not sustain for a lifetime.
The retirement income world of 2032 is going to be very different from that of 2004. The purpose of auto-enrolment is to encourage a large proportion of the population to build retirement savings that can be used during their retirement as they wish. To me, therefore, the highest participation rate should be the objective, not raising the minimum contribution rate with the danger that large numbers will opt out.
When saving for retirement becomes the norm, we can then help those people identify why they will benefit from additional savings and how to identify when they can afford those savings.
Bob Champion is chairman of the Later Life Academy