What should the next government prioritise in relation to pension policy, and are there industry benefits to political instability? We posed this question in the 11th edition of the PMI Students' essay competition, sponsored by ITM.
We're thrilled to announce Rhys Keeling, Business Development Executive at Wealth at Work, took home second prize. Sarah Meehan and James Turner earned first and third prizes, respectively.
Rhys Keeling's Essay
The Future of Pension Policy: Prioritising Adequacy, Financial Literacy, and Engagement
The new government has a key role in setting policies that will improve outcomes for future retirees. To this end, pension policy should focus on ALE. Because we all know how much the pension industry loves an acronym! ALE is adequacy, literacy and engagement. We need to get people to save more, save better and use more wisely. I believe adequacy, literacy and engagement should be used to guide reforms.
In my view the focus should sit in two areas which I’m going to discuss throughout the essay: auto-enrolment and financial education.
Auto-Enrolment: A Solid Foundation Needing Improvement
12 years on from its introduction, my view is that auto-enrolment has been one of the most significant pension policy achievements in recent times. With the introduction in 2012, it has increased the amount of workers saving for retirement, with over 11 million people participating [1]. However, while auto-enrolment has increased participation rates there are over 33 million people aged over 16 working in the UK [2], and so there are large portions of society not participating and for those that are participating, the present contribution levels aren’t satisfactory for ensuring the retirement that most would like to achieve. So, how do we improve auto-enrolment to build on the solid start?
Currently the minimum contribution amount is set at 8% of ‘qualifying earnings’. This 8% contribution percentage could be deemed to be an insufficient contribution for the vast majority, as it won’t enable them to achieve a satisfactory retirement income, as highlighted in the PLSA retirement living standards [3].
Experts, such as former financial secretary, Stephen Timms, has said that a contribution of 12% is required to achieve a more assured retirement [4]. Thus, increasing the auto-enrolment contribution percentage should be a priority.
Raising the Contribution Rate
A higher contribution rate would enhance the retirement savings of millions of workers across the UK, which in turn would aid in reducing future dependence on state benefits. Moving the auto-enrolment contribution rate from 8% to 12% would be a significant move to enhance pension adequacy. If we look at the example of the changes Nationwide made to their pension scheme, in which they automatically defaulted people to the maximum match, the scheme went from having 8% of people paying the maximum, up to 90% paying the maximum [5]. This shows that it works! The biggest challenge is the increase in costs to employers, but if they want people to retire then they have to help them to save enough!
Improving Pensions for the Self-Employed
Currently there are 4 million people self-employed within the UK [2]. Thus, another key part of any reform is the inclusion of self-employed workers within the auto-enrolment system. Unlike those that are employed, self-employed workers are not automatically enrolled into a pension scheme, and they lack the benefit of employer contributions. As a result, there are pension gaps between the self-employed and employed workers. To address this gap, any reforms must look at solutions that don’t exclude the 4 million self-employed workers. Building on the success of auto-enrolment in the employed space, a form of auto-enrolment for the self-employed could be introduced. In practical terms, this could be linked to the self-assessment tax return process, or though areas such as tax breaks or government matching contributions, which would promote voluntary pension savings and remove reliance away from the state pension.
Lowering the Age of Entry and Starting Contributions from the First Pound
Under the current system the age of entry for auto-enrolment is 22 years old, with contributions then based on earnings that are above the threshold. This entry age and earning threshold, may result in a worker not starting their pension savings for a number of years, which could in, have a substantial effect on the total amount accumulated over a working life. As per Wealth at work’s latest research, we can see a 1% increase in savings each year can boost future savings by 25% [9]. To address this, the government should lower the age of entry to 18 and ensure that pension contributions start from the first pound earned.
A lower age of entry would allow workers to begin building their pension pot from an earlier age, taking advantage of the superpower that we all know compound interest can be. A change like this would ensure that all workers, regardless of age or income, have the opportunity to save for retirement from the earliest possible opportunity.
Enhancing Financial Literacy: The Role of Education
Financial literacy is defined as the ability to understand and effectively use various financial skills, including personal financial management, budgeting and investing [7]. As per research from Wealthify and the CEBR, financial literacy across the UK is extremely low, with three quarters of respondents falling below the benchmark [8]. What does this mean in practice? Well, a lack of literacy will result in people being at a disadvantage and leads to a detrimental impact on financial health. Looking at this it is clear we need to implement a process of improving financial literacy across all age groups, ranging from young people in schools and up to those that are already retired. Improving literacy is vital to enable people to make informed financial decisions about every aspect of their financial life, not just retirement savings, but also understanding the impacts of various investment decisions and being able to plan successfully for their future.
This lack of understanding can lead to adverse decision-making, such as opting out of pension schemes, under-saving, or making high-risk investment choices such as crypto, without the necessary understanding of the consequences.
Financial Education
This issue is going to take time to improve, but in my view, it is important to start building financial education as young as possible, thus financial education should be integrated into the school curriculum from an early age. Schools should teach students about a range of key topics, such as the importance of saving, the basics of investing, and how pensions work. If we start building financial literacy from a young age, it will ensure that the next generation are going to be better equipped to manage their finances and make informed financial decisions.
Alongside the school-based education for younger people, it is important to look at a solution for current adults. The government should support adult financial education. This could include providing free resources and workshops through community centres, online platforms, and workplaces. The government could also make it a statutory requirement alongside pension contributions for employers to offer pension education sessions as part of their employee benefits offering, as well as making guidance on pension access compulsory.
Targeted Campaigns to Increase Engagement
As a way of increasing engagement with pensions and bringing pensions into the everyday conversation, the government could use targeted public awareness campaigns. Targeting these campaigns will ensure that people are getting the right message at the right time, ensuring the messages they’re receiving are relevant to their particular situation. These campaigns could be focused on key life stages. Such as, a nationwide campaign aimed at young workers in their first job concentrating on how to understand your payslip, what your tax code means alongside explaining the power of starting pension contributions as early as possible, whilst a campaign aimed at new parents could emphasise the importance of saving for retirement alongside saving for their children's future. Linking pensions to relatable life events, will make the concept of retirement planning more tangible and relevant to people.
Many individuals lack the necessary knowledge to make informed decisions about their retirement savings, which can lead to people not choosing the best possible outcome. This is highlighted in Wealth at Work’s pensions engagement research [6], which highlighted 29% are unaware that their pension is invested and 49% were unaware of what their pension is invested in.
Implementing nationwide financial education programs and ensuring that pension information is transparent and easily accessible can empower individuals to take control of their retirement planning. For instance, Denmark’s "Pension Info" platform provides a comprehensive overview of individual pension entitlements from all providers. Our version of pension dashboard is coming, however there have been delays. The new government should push ahead with launching a national version and allow the commercial dashboards to follow. I am of the opinion that a solution that is 80%, is better than not doing it or delaying until it’s perfect. They could also make one to one coaching on any financial topic entirely tax free, moving away from the current position of it being a benefit in kind.
Simplifying Pensions
A barrier to pension engagement is the complexity of pension products, the confusion surrounding investment options and the complex language that is often used within pensions. People can find pensions difficult to understand and are overwhelmed by the range of choices, leading them to disengage from the process altogether. I used the ALE acronym earlier and mentioned that the industry as a whole loves to use acronym. This doesn’t help those that sit out of the industry! The overuse of acronyms and complicated language adds a layer of confusion that could be avoided.
The government should act in tandem with the pension industry to simplify the information provided and to ensure that products are more user-friendly. This could involve standardising statements to make them easier to understand, offering default investment options that line up with an individual's risk tolerance and retirement goals, and providing simple tools to aid comparison.
Are there industry benefits to political instability?
There are a handful of industries that may benefit from the volatility that political instability brings. Volatility of any kind will create opportunities. An example of this is highlighted by the financial sector, particularly, hedge funds. They take advantage of political uncertainty and find ways of thriving due to the increase in market volatility, making political instability a potential positive for this sector.
Creating a Stable Policy Environment
However, while there are a handful of industries that may well benefit from some political instability, overall economic growth, trust and engagement is best achieved by a stable policy environment. Political stability can lead to growing investor confidence, whilst encouraging both investors and pension funds to focus on long-term planning, and advocates for sustainable economic development.
If governments can work towards creating a stable policy landscape, this will reduce uncertainty and will support investment and innovation. A few ways of achieving this could be through transparent policymaking, consistent regulatory frameworks, and efficient governance.
Income Inequality and Social Cohesion
Stability is also directly correlated to both social cohesion and income equality. High amounts of inequality within a country can lead to both social unrest and political instability. Consequently, this will undermine economic growth and stifle investment. Therefore, working to address inequality through a combination of progressive taxation, social welfare programs, and economic policies that are inclusive can help to preserve political stability and can foster sustainable growth.
A great example of this is seen with the Nordic Countries. They demonstrate comprehensive welfare systems and harness a commitment towards achieving social equality. This displays how policies that are enacted with the focus of working towards fostering income equality can reinforce political stability and economic resilience.
Conclusion
The next government faces significant challenges in ensuring that the UK pension system meets the needs of its citizens in the coming decades. But in my view by focusing on adequacy, financial literacy, and engagement, policymakers can create a more inclusive, equitable, and sustainable pension system that provides long term security for all retirees.
Key reforms should include increasing the auto-enrolment contribution rate to 12%, improving pension solutions for the self-employed, lowering the age of entry, and starting contributions from the first pound earned. These structural changes must be supported by efforts to enhance financial literacy through education and targeted engagement campaigns.
Last update: 4 December 2024
