How the UK Saves: The effects of contribution phasing

As the second round of ‘phasing’ begins to be implemented, Will Allport, from our strategic partner, Vanguard, shares insights from the research we’ve done together to understand the effects of the first increase:

The experience of increasing the minimum auto enrolment contribution through a series of steps, known as phasing, has yielded some interesting insights into the behaviours of members of occupational pension schemes. In our view, this kind of data-driven evidence can be of particular value in improving outcomes for end-investors.

In 2018, Vanguard and Nest Insight together published the first edition of How the UK Saves,
a study of data underlying the largest retirement savings initiative ever undertaken in the UK –
auto enrolment. Beginning for the largest employers in 2012 and finishing with the smallest in
2017, employers were required to automatically enrol eligible employees into a qualifying
workplace scheme.

Auto enrolment began with minimum total contributions of 2%. This was made up of 1% from the employer and 1% from the employee, reducing to 0.8% following tax relief for anyone earning less
than the marginal rate.

Policy-makers knew that this initial contribution rate would be insufficient to deliver successful retirement outcomes. It was always planned that the minimum contribution would require incremental increases.

The first of these increases took place in April 2018. This raised the employer contribution to 2%
and the employee contribution to 3%, or 2.4% after tax relief. The second increase is due this month (April 2019). It raises the employer contribution to 3% and the employee contribution to 5%, or 4% after relief.

The first increase has already provided us with rich data to help further understand savers’ behaviours. Before getting to the data itself it’s worth revisiting our expectations prior to the
phasing exercise commencing.

One of the great successes of auto enrolment was the low opt-out rates. Considering that wages
had increased between 2012 and 2018, there was an expectation that the first increase in employee contributions would represent a small – perhaps unnoticeable – change in the nominal level of year-
on-year income. The behavioural finance specialists amongst us suggested that “inertia” would continue to be a dominant force, in part because nominal earnings tend to be the most
psychologically significant.

The data – by and large – bore out our expectations. Our analysis of Nest member data shows that
the 2018 increase has had no material impact on retirement savings behaviour. In the five months after phasing, member-led cessations were just 0.3% higher overall than in the preceding five months. The total proportion of members ceasing payments increased by only 1.5 percentage points. Not all the cessations will have been attributable to the increase in contributions. Some, at least, are likely to be due to such factors as seasonality, though there is more work to be done in this area.

Our research emphasises the fact that member inertia has a powerful impact on retirement savings behaviour. This is reflected in the small percentage of members who reacted to the mandatory contribution increase and confirms the importance of inertia to the efficacy of auto enrolment.

As we look forward to the imminent second (and as things stand, final) phased increase of contributions, we hope to see similarly ‘unexciting’ results. We expect this to be the case, given that early indications suggest that nominal incomes will have increased in 2018—19 to a level to cover the increase. This will be a topic for analysis in our 2019 edition of How the UK Saves, due out in October.

There is an important policy question still to be considered.

Employees opting out of auto enrolment have to be re-enrolled after three years. Opting out, though, is either in whole or nothing. For example, if a member is settled at 2.4% of their nominal income, but resists the increase to 4%, they can only opt out to zero. They would then be re-enrolled three years later at 4%. Instead of the all-or-nothing approach, would it not be better to allow temporary opt-outs of each increment?

Saving 2.4% (5% of gross income when tax relief and employer contributions are counted) might not be as good as saving 4% (8% in total), but it is a lot better than nothing.

Will Allport, Senior Strategist at Vanguard

Further reading

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