How much is enough? Saving adequacy, Turner, and auto-escalation

5 August 2015

Underpinning the Chancellor’s recent consultation on pension tax relief was the proposition that “Britain isn’t saving enough.” Policymakers across Westminster agree millions face inadequate retirement incomes, but there is a lack of clarity about what this means. Pensioners need – at a minimum – to sustain themselves, but individuals are more ambitious than this. Many want to maintain their current standard of living while in retirement.

It is this second definition that has informed the Department for Work and Pensions’ (DWP) thinking on saving adequacy over the past decade. An individual’s savings are measured against a target percentage of their average working life salary. If a retiree’s pension cannot fund an income above the set ‘replacement rate’, the individual has inadequate savings.

Drilling down into the detail of these targets – which were developed in the Turner Commission’s first report – reveals a limited relationship with the replacement rates desired by today’s workers. Survey data developed by the Turner Commission indicated a considerable disparity between what we want in retirement and what we actually achieve.

The contrast was most marked for those on low incomes, a likely reflection of dissatisfaction with present wages. However it is the other end of the spectrum that should be more concerning. Those on higher incomes have the financial capacity to achieve the replacement rates they desire, yet in 2005, those earning over £40,000 averaged a replacement rate of just 18 per cent. Even when the State Pension is taken into account, many individuals in this income group will experience a considerable cut in their monthly income. These issues are still live today. The OECD’s most recent study indicates that gross replacement rates have fallen further, with the most marked drop registered for those on low and middle incomes.

Cognitive biases explain these trends. Individuals undersave because we are fooled by the money illusion, feel loses more keenly than gains, and are prone to procrastination. Auto-enrolment was a recognition that these biases could be harnessed to secure better outcomes for individuals, but present contribution levels are too low for those on middle and high incomes to reach their ambitions. Auto-escalation schemes – which gives individuals the opportunity to pre-commit to saving more in the future – could be an option. Trials in America have demonstrated these schemes can help those most exposed to undersaving reach their retirement ambitions. Whether these ambitions are realistic is another point altogether, although here too the government could take action.

Critics will say this is thinly veiled paternalism, but auto-escalation is about helping individuals achieve their own goals, not telling them what to do. Too often policymakers talk in abstract about saving adequacy without reference to the outcomes individuals want. Policies such as auto-escalation, that switch attention to the realistic goals of individuals and away from centrally set targets, would be a step in the right direction.

William Mosseri-Marlio, Researcher, Reform

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