Pensions bulletin: Nudges and NEST eggs

Whether it’s a nudge or a hard shove, governments around the world have resorted to varying degrees of compulsion to get their citizens preparing adequately for retirement.

Australia, Chile and Sweden have opted for “hard” compulsion by forcing employees or employers, or both, to contribute to workplace pensions. In contrast, the UK and New Zealand have plumped for a softer approach, which sees employees nudged, or defaulted, into pension schemes chosen by their employer, but free to opt out if they wish.

So far, the British system of soft compulsion, known as automatic enrolment, has proved a success—with seven million people auto-enrolled by more than 300,000 employers since the policy was launched in 2012. Cash saved into workplace pensions—thanks to auto-enrolment—stood at £81.8bn in 2015 an increase of £7.1bn since 2012.

Significantly, only around one in 10 auto-enrolled workers has chosen to opt out of their workplace pension.

But while these achievements are impressive, progress of the policy is expected to become trickier as the coverage of automatic enrolment extends to hundreds of thousands of small and micro employers. Also, minimum contribution rates, from employee and employer, rise from the current 2 per cent to 5 per cent and then 8 per cent by 2019.

The government has so far shown little desire to step up to a more muscular approach if the nudge tactics of auto-enrolment falter. But the UK’s pension industry believes full compulsion should not be ruled out.

“Automatic enrolment has been a success so far,” said Yvonne Braun, Director of Long-Term Savings and Protection at the Association of British Insurers. “But if the new Lifetime ISA (launched in April) generates mass opt-outs of workplace pensions then we need to consider making automatic enrolment compulsory.”

While debate continues over the role of compulsion in bridging the UK’s substantial savings gap, calls are growing for rules governing how people can access those savings to be reviewed. Radical changes to pension rules in 2015 removed the effective requirement for retirees to buy an annuity—or secure income for life—with their defined contribution (DC) savings. Instead, over-55s were free to spend their DC pot as they wished.

Two years on and there is mounting disquiet over the choices savers are making following the introduction of these new “pension freedoms.” Recent data showed nearly 80,000 pension pots were cashed in during the third quarter of last year. Around 40,000 drawdown policies—where cash is left exposed to stock market volatility—were opened.

At the same time, 20,000 annuities were sold, a sharp contrast to three years ago when these policies were the dominant retirement income products.

Of most concern to many commentators was the fact that fewer than half of those who fully drained their pension pots sought the help of a regulated adviser, according to Financial Conduct Authority data.

“Into retirement there is more still that needs to be done with regard to getting the defaults right,” said Steve Webb, Pensions Minister when the pension freedoms were launched. He is now Director of Policy with Royal London. “Whilst the pension freedoms have made pension saving more attractive and give younger retired people new options, there are big issues around the role of individual choice in later retirement.”

But he added: “the answer isn’t defaulting people back into annuities.”

NEST, the government-backed workplace pension provider, last year put forward a plan to make the pension freedoms less complex for its four million members, largely low earners who don’t appeal to advisers.

A default “retirement pathway” would offer steady income in the form of a drawdown account, a rainy-day cash fund, and longevity insurance, in the form of a deferred annuity, which begins to pay a secure income from the age of 75. “While ‘Freedom and Choice’ can be of great benefit to those who do not wish to purchase a traditional annuity, there are also more opportunities for people to make poor choices or even fall victim to scams,” said NEST. “NEST members—and others—need simple pathways into well-governed products.”

Tim Sharp, Pensions Policy Officer with the Trades Union Congress, believes retirement options of the sort proposed by NEST are needed. “Pension freedom asks too much of the individual,” says Sharp. “There is not the market pressure on providers to offer the kind of products that are in the long-term interests of low and middle-income savers, and society in general, which must include an element of longevity insurance or risk pooling.”

While the government decided against allowing NEST to develop its default decumulation strategy for now, experts believe the pension freedoms will face a rethink. “The current aim of the UK decumulation policy is to give people choice, but once we have seen the choices people have made, then the UK framework may need to be reviewed,” said Chris Curry, Director of the UK’s Pensions Policy Institute.

“Without some kind of improved framework, which could include defaults, it is unlikely we will see people choosing a guaranteed income solution.”