In this edition we focus on why, how and to what extent to increase contributions to defined contribution
schemes if good retirement outcomes in the UK are to become the norm.
What is a good retirement outcome?
The central theme running through Pensions Watch to date has been the need to make good retirement
outcomes in the UK the norm. Defining what constitutes a good retirement outcome has been made easier
by the PLSA’s Retirement Living Standards.1 The PLSA suggests, as a rule-of-thumb, that for a single person in
retirement, a gross income of £10,200, £20,200 and £33,000 will respectively provide a minimum, moderate
and comfortable standard of living. For a couple, the corresponding numbers are £15,700, £29,100 and
£47,500.2 To put this into context, for someone with a full 35 year NICs record, the State Pension in 2020/21
pays £8,767 at State Pension age (SPa) – equivalent to 28.4% of pre-retirement income for the average
UK earner.3
As people increasingly become solely reliant on their defined contribution (DC) pension pots to support
their standard of living in retirement, achieving each of these outcomes is partly contingent on the amount
a DC saver contributes over their lifetime to their DC plan(s).4 Currently, the median employee and employer
contribution to an occupational DC trust-based scheme is 4% and 3% of band earnings respectively,5 while
the minimum total contribution to an auto enrolled scheme is 8%. And therein lies the problem. According to
the Pensions Policy Institute (PPI), “a median earner might need to contribute between 11% and 14% of band
earnings to have a two-thirds chance of replicating working life living standards if contributing between age 22
and SPa.”6 Additionally, the Resolution Foundation, in seeking to establish what constitutes a socially-acceptable
adequate standard of living in retirement for low to middle income earners,7 suggests that, “low-to-middle
income employees aged 25 today would need to save an additional £600 a year …equivalent to 3% of gross
earnings, and a 35-year-old would need to save an additional £1,300, equivalent to 7% of gross earnings.”8
Although recently reduced consumer spending is showing up in a dramatically higher (short-term) household
savings ratio,9 the current economic environment is, quite understandably, diverting attention away from long-term
saving. However, delaying, cutting back or taking a break from contributing to a pension scheme, even for just a
few years, can have a marked impact on the percentage of earnings that will need to subsequently be saved if
one’s standard of living isn’t to suffer in retirement. Such is the power of compound interest.
So how do we achieve materially higher DC contribution rates?
Although the long mooted widening of auto-enrolment eligibility would achieve more widespread pensions
saving, to achieve materially and enduringly higher DC contribution rates, policymakers essentially have two
choices (three if you include member education).10 They can (1) compel the nation to save, or (2) implement
simple behavioural interventions to overcome those deeply engrained and indiscriminate behavioural biases
that prevent savings levels rising to wholly more appropriate levels. Aside from compulsion going against the
more libertarian ethos of contemporary pensions policy,11 in a democracy people generally don’t like being
explicitly told what to do with their own money. By contrast, overcoming the cognitive barriers to increasing DC
contribution levels by moving people gently towards more optimal behaviour is a more subtle and surreptitious
approach to achieving desired outcomes.12 Moreover, when applied correctly, these interventions can focus on
both the disengaged, those who can’t or won’t help themselves (think auto enrolment), and support the active
engagement of those capable of helping themselves if given an easy and emotionally accessible opportunity
to do so. The latter is facilitated by the EAST framework of making actions and prompts easy (removing the
“hassle factor” associated with performing the desired action, e.g. requiring just one click), attractive (using
personalisation, simple and positive language and visuals, appropriate media and novel incentives to make
a course of action appealing), social (creating positive social norms by socialising desirable actions and
behaviours) and timely (prompting individuals to change behaviours at those pivotal times in their lives when
they are most receptive to engagement).13
The most prevalent and destructive of these cognitive barriers to overcome are present bias and
anchoring. Present bias is the, typically strong, preference for consumption today over deferring consumption,
by saving, until tomorrow. Indeed, for many, retirement is too far away to be relevant to their decision making
today, not least because individuals find it difficult to visualise themselves in later life. So the savings decision
effectively becomes a choice between spending on yourself today versus saving for a stranger to spend your
money in the future. This is compounded by the tendency of many pension savers who mentally anchor14 their
pension contributions to either the automatic enrolment minimum contribution level or that applied by their
workplace pension scheme in the mistaken belief that these have been endorsed, by the government or
their trusted employer respectively, as being adequate to provide a comfortable retirement.
The reality is, of course, so, so different.
Overcoming present bias and anchoring
Present bias can be overcome by better aligning the immediate costs and future benefits of saving by a
combination of making the costs appear less immediate and the benefits more immediate and salient.
For instance, projecting an image of how someone might look 30 or 40 years from now dramatically improves
their engagement with retirement planning,15 not least because they can identify with their future self and how
many of today’s activities and expenditures they will continue to enjoy far into the future – so making the benefit
of saving more salient. The Save More Tomorrow approach of automatically escalating DC member contribution
rates is another such initiative. Here, DC savers commit today to paying increased contribution levels only in
the event of receiving future pay rises. By not having to pay any money today, the individual delays this cost
while ensuring that their future is better catered for.16 Then there’s issuing a national lottery ticket for, say,
every £100 per month saved. Lottery prizes are attractive in that people tend to focus on the prize (indeed,
visualise themselves sitting on a big pile of cash) rather than the small probability of winning it.17 In addition
to better aligning the immediate cost of making a higher monthly contribution with a potentially much larger
immediate benefit, introducing lottery tickets can also help to move contributions away from the minimum
contribution “anchor”.
Lottery tickets aside, anchoring is typically addressed by using simple language, positive words, attractive
framing and by expressing actions in pounds and pence rather than percentages. Simple messaging such as,
“save three days’ salary per month” or “save your age multiplied by 10 per month” resonates with people and
is instrumental in moving the contributions “anchor” to a more realistic level.18 Another is reframing pensions
tax relief as a “savers bonus”, and using sufficiently, but not unpalatably, large numbers to illustrate how the
bonus works, e.g. a £50 bonus is received for every £200 saved. Likewise, positioning employer contributions,
especially those that match or escalate at a faster rate than employee contributions, as “free money”, again
encourages employees to move beyond the minimum contribution rate.19
Why does this matter?
Addressing the inadequacy of retirement provision, partly as a consequence of sub-par DC contribution rates,
remains one of the UK’s biggest socio-economic challenges. Indeed, the aspiration to generate good financial
outcomes at and in retirement typically fails to meet the reality by some margin judging by current and
projected future income replacement rates.
When applied correctly, behavioural interventions have the capacity to motivate greater levels of retirement
saving and ultimately move the nation towards achieving good financial outcomes. It is also a more palatable
policy tool than compulsion. However, behavioural interventions, while effective, are best applied not in
isolation but in conjunction with people being properly supported throughout the entire retirement planning and
implementation process. In so doing, people will feel empowered to make better and more informed decisions
and so move the nation closer to addressing the inadequacy of retirement provision.
