Auto-enrolment has been rolling out for a couple of years now, first with large private sector employers, then public sector, and SMEs are in the implementation process now. So far, opt-out rates have been very low, and the government now only expects 15% of employees to opt out, rather than its initially predicted 30%.
This is very good news. The uncomfortable truth surrounding all pension reform – including unsavoury public sector pension reform – is that everyone needs to pay longer, for less in order to pay for retirement. If we’re going to navigate our way through this mess everyone needs to contribute.
However, we’re still in the early stages, and contribution rates are still low – 1% from the employee, matched by the employer. For some people that’s on top of their salaries, great, for others, that’s up to 2% more taken out of their pay packet. Not so great. That’s easy enough to swallow when it’s just 2%, but by the time it gets up to 8% – or higher; many experts recommend contribution rates of around 15% – opt-out rates are bound to rise.
That’s not something we as a nation can afford. The question hanging over auto-enrolment from the beginning has been whether it should be compulsory. There’s certainly a strong case for mandatory workplace pensions.
If people can’t pay for their own retirement – and the evidence is that most people don’t save enough by themselves – then they end up relying on others to pay for them. And that means the taxpayer. And when the tax base is smaller than its dependants (as is set to happen with an ageing population) that’s a recipe for disaster. You can’t turn to a pauper for help.
Although the libertarian lobby will rail against anything mandated by government, when some organisations estimate we’ll need a £400,000 pension pot for a ‘basic standard of living’ and the average British pension pot, when left to our own devices, is only around £40,000, we clearly need more than a nudge. The argument to leave us alone only works if we follow it through to being allowed to die alone in our freezing flat at the age of 79. Which is something the British welfare state will not allow.
But libertarians do have a point. Individual liberty should be primary in a liberal democracy. Mandatory pensions makes sense because failure to save enough for your own retirement harms other people (violating the principle of liberty) but there are situations where it would be appropriate to opt out.
For example, high earners or those with substantial capital could find themselves violating the £1.5 million lifetime allowance through participation in an auto-enrolment scheme they neither want nor need. And financially savvy workers, of all income levels, may wish to build up their pension in another way, or through a different scheme to that their employer subscribes to. If that’s what they intend to do, they would be permitted to do so.
So what’s the solution? If opt-out rates do rise to unsustainable levels, particularly in time for the pension review set for 2017, and compulsory pensions take on the air of necessity, then we need ensure the scheme answers the arguments against.
Opting out should still be permissible, but to do so must be a means tested, active process. You are only allowed to opt out if you can demonstrate alternative means. Much as the old rules for annuitisation used to be before Osborne’s liberalisation of the process. This would cover people who wish to pursue retirement savings in a different way, and those on higher incomes seeking to avoid tipping over the lifetime allowance.
Workplace pension schemes should be excellent value for money, so that financially savvy workers don’t even want to opt out. This should be requirement anyway, but doubly so if compulsory. If I’m forced into doing something, it’d better be unequivocally good for me. This means ensuring annual management fees are reasonable, and returns are consistent with alternative schemes.
The latter point cannot be guaranteed, though steps can be taken to support it. The former may mean instituting Dutch style collective pensions and using bulk bargaining power, along with economy of scale, to drive fees down. Approached correctly, workplace pensions could be the most value for money pensions on the market.
If the opt-out rates stay as positive as they are now, then mandatory pensions may never come up. But if participation drops significantly, there is a strong case for compulsory enrolment done right. On pure economics, compulsory pensions makes most sense, and auto-enrolment is, as an OECD review into the Irish pension system put it “second best”. You have to make it politically palatable.
Not to sound paranoid, but starting with auto-enrolment at a low contribution rate seems a good place to start.