Saving for retirement Is 12% the solution? Whitepaper
Contents 3 Executive summary 4 The challenge 7 Potential solutions 7 - Personalised engagement 9 - Sophisticated contribution level management 11 A future vision Aquila Heywood Saving for retirement 2
Executive summary While Auto-Enrolment has been a success, there is still much to be done to increase the level of retirement savings further. 12% of a salary is often quoted as the target level needed for pension savings. Yet a flat target percentage is not suitable across the board and will not address the retirement challenges of some of the most important sections of the population. Longterm savings targets need to be personalised to a much greater degree, backed up by effective technology-driven engagement. Aquila Heywood Saving for retirement 3
The challenge The Government recently released its review of Automatic Enrolment (AE). This considered the policy so far and examined how Auto-Enrolment could be further extended to increase both the amount being saved and the number of people saving. While AE has been a success, with a 400% increase in the number of people saving in the last eight years, there is evidence that many people will still be retiring with insufficient funds. This is despite the planned escalation in contribution rates under AE in 2018 and 2019. The DWP report 1 shows that, while AE will help to reduce the number of those undersaving (the number of people expected to have an adequate retirement income is increasing by two million) 1, there will still be around 12 million people in retirement in 2100 1 with inadequate pensions. The following graph shows a breakdown of under-savers by income bands. Number undersaving 7.0m No AE Current system 6.0m 5.0m 4.0m 3.0m 2.0m 1.0m 0.0m Band 1 (< 13,000) Band 2 ( 13,000-24,999) Band 3 ( 25,000-34,499) Band 4 ( 34,500-55,499) Band 5 (> 55,500) Gross pre-retirement earnings (2017 earnings terms) 1. DWP 4
In absolute numbers, of the 12 million people that will retire with insufficient funds, ten million earn over 25,000 1. The fact is there is a much bigger impending issue with middle-income earners facing significant reductions in financial wealth in retirement than with lower earners. For those on low to medium incomes, the current planned AE contribution rate of 8%, (starting from age 21), alongside the state pension, should provide a good replacement ratio (that is, pension replacing earnings) in excess of 80%. In this segment, AE savings at the planned 2019 levels will more than meet retirement needs. Indeed, increasing contribution rates further for these lower earners means many will end up having a replacement ratio in excess of 100%. That seems an illogical policy, pushing poorer people to save more than is necessary at the expense of income for day-to-day living. Indeed, there is a risk for this cohort that reducing their take-home pay by too much will make them more likely to drop out entirely. This would escalate the problem rather than mitigate it. Conversely, at the middle to higher income brackets, the 8% AE contribution is less likely to deliver the income needed for an adequate retirement, with the DWP report suggesting that, for higher earners, there will still be millions of people under-saving. For this cohort a 12% of salary contribution target (or even higher) is required. The Government, with its suggested changes in the review, has focused on getting those in the lower income bands saving more. For example, the proposal to remove the earnings threshold will increase AE pension savings by 800 which, for an individual earning 11,000, is a 7.2% p.a. increase in contributions but, for someone earning 28,000, is just a 2.9% p.a. increase. Naturally those in the 18-21 age bracket will typically fall into lower earning bands, so the impact of this change will be felt more at this younger age. 1. DWP 5
A lot of attention has been on the contribution rates that apply when AE is fully rolled out, with many commentators suggesting that 8% is not sufficient. A figure of 12% is most commonly quoted, with many commentators basing their evidence on the experience in Australia, where 12% is the minimum. But is the answer to the problem simply increasing the contribution rate? As our initial examples demonstrate, it is not that easy. Higher contribution rates than currently planned under AE are most definitely required for some, but the target percentage needs to differ for different groups of the population. Looking beyond the simple examples above, there are many other factors that must be considered when setting a personal retirement savings target. The starting age is an obvious one: a person enrolling into a pension for the first time in their 30s has less time to build up a decent pot than someone starting in their 20s, and therefore needs to contribute more, all other things being equal. Similarly, other wealth should also be considered; those with property or ISA savings have the means to supplement a pension and hence can target a smaller percentage of their salary as their retirement contribution. 6
Potential solutions Fundamental to any solutions to this challenge are the twin themes of engagement and personalisation, allied to a more sophisticated management of contribution levels. Personalised Engagement The pensions industry has recognised that much more effort needs to be invested in improving engagement. Financial wellness in the workplace is a hot topic at the moment, with employers keen to attract staff through a more holistic benefits approach, while also tackling the problem of stress in the workplace caused by personal financial management issues. In addition, engagement in long-term savings is crucial to ensure staff can actually afford to retire. Many employers are now seriously worried about having a number of older staff stuck in the workforce, because they cannot live adequately without their income. It is also increasingly recognised that engagement has to be much better directed. Each person has their own unique circumstances: individual financial positions, different family needs and life objectives, different levels of education and financial awareness, and different preferences for how and when they learn new things. Engagement, therefore, has to be much more finely tuned to the needs of the recipient and should be delivered through their preferred media and communication channels. Whether considering employees in the workplace or the wider consumer needs for long-term retirement saving, technology is crucial in underpinning powerful, effective engagement. Maintaining high-quality and value-added data on each person is key. Good quality data analytics can then be used to interpret the data and to personalise each communication or drive engagement programmes. 7
Mortgage/ rent Spending Interest in money Communication preferences Banking Inheritance plans Financial awareness Family needs Savings Debt Elements that make up an individual s financial circumstances This has to be supported by a range of different engagement tools that reflect the individual s communication preferences, for example, video-based education or behavioural driven games to help assess financial needs. In the workplace context, the employer is ideally placed to drive this enhanced engagement, given the benefits that accrue to the employer and the employee. For individuals outside the workplace, there are a host of potential communication channels that need to work in concert to help promote savings (for example, Department for Work and Pensions, pension product providers, banks and anyone else that touches on a person s regular spending and saving). This is an area where innovation, while still in its infancy, is making in-roads with robo-advice, artificial intelligence and the expanding use of social media. This is because these channels are all becoming tools for people to use to engage with their pensions. 8
Sophisticated contribution level management Returning to the specific question of contribution levels. A wider range of engagement tools can assist individuals in understanding the need to save. But much can also be learnt from the first stages of auto-enrolment where having a positive default of in was crucial. Once enrolled, individuals stayed in through inertia. That inertia will also play a large part in ensuring individuals stay in auto-enrolment as contribution levels rise over the next few years! An extension to the default approach can be applied to middle / higher earners to help them save greater amounts to address their under-saving issues for their retirement. The principle follows the save more tomorrow (SMarT) programme proposed by Richard Thaler in 2004. Auto-escalation (as SMarT has become known) can take several forms, but generally involves an individual agreeing to have their contribution percentage automatically increased until an upper limit has been reached. In the original SMarT idea, the increases can be triggered purely on dates and are not salary-, age- or eventrelated. An alternative, arguably one that is likely to be more popular with employees, is to link contribution rate increases to promotions or salary increases. As people receive pay rises or move through salary bands via promotions, they are either nudged to use some of the extra income for pension contributions or they agree upfront to have this happen automatically. The evidence from the few schemes that have implemented traditional autoescalation is that members are unlikely to opt in, and those that do opt in then opt out before the ceiling is reached 2. This suggests that making auto-escalation linked to salary increases, with a default of being opted in, making use of inertia, is more likely to achieve the desired long-term improvement in contribution rates. Equally, the evidence highlights the importance of linking a SMarT style option to wider personalised engagement initiatives that really sell the benefits to the individual. 2. SMarT Programme 9
A different example of where nudges could be beneficial can be seen in the personal financial management app from Money Hub 3. The app looks at an individual s regular spending patterns and highlights where money savings can or have been made, and then prompts the person to do something more positive with that spare money. Linking this sort of solution into a workplace context would enable those nudges to be focused on topping up long-term savings. Source: Money Hub 3. Money Hub 10
A future vision From Aquila Heywood s own experience, the personalisation aspect is perhaps the most important area for technology investment, and is something that is being actively supported. Aquila Heywood is taking part in a number of initiatives and developments, to enable this to happen much more effectively in the future, including The Pensions Dashboard. The Pensions Dashboard, allied to the new open banking standards, will soon enable a person s total savings position to be known. Modern educational tools, gamified modellers, automated advice systems and understandable communications can come together to help an individual understand their finances and start to plan better. This individual can then be given a contribution strategy that reflects their personal position and builds towards a decent retirement. Ongoing communications such as personalised video-based benefit statements or nudges from personal financial apps can reinforce the learning points, the financial plans and the savings benefits specifically for that individual. That is the power of the technology that can address the longterm savings gap! For more information, contact us at enquiries@aquilaheywood.co.uk or visit our website: https://www.aquilaheywood.co.uk Aquila Heywood Saving for retirement 11