The government says it is time for a review of retirement adequacy. DC schemes should take note, say Steven Leigh Associate Partner, and Aneesha Sunner, Consultant at Aon.
The Labour government has lost no time in fulfilling its manifesto promise to review the pensions and retirement savings landscape. Pensions Minister Emma Reynolds has set out a Terms of Reference for the review, with attention turning to retirement adequacy later this year.
Saving for an adequate standard of living in retirement is unlikely to happen by chance. It requires defined contribution (DC) schemes offering appropriate contribution rates, good scheme design and helping members to make informed choices. But only a minority of schemes know whether they are on track to deliver an adequate retirement for their members at present.
Pension contributions and adequacy are one of the Five Steps to Better Workplace Pensions identified in Aon’s 2024 DC survey findings. We spoke to 214 participants – mostly trustees, pension managers and HR/benefits professionals – from DC schemes of different sizes and in different industries. Between them, they are responsible for over £60 billion of DC savings. While most have a good knowledge of contribution rates, nearly two thirds said they didn’t know the expected outcome for members of their scheme.
Contribution Stagnation
Our research found that, although there is a wide variation in the minimum rates and contribution strategies offered by employers, the median joining level of company contribution has remained at around six percent since 2019. This suggests that many employers have not reviewed their contribution structure recently, despite growing concerns around pensions adequacy.
The range of responses is wide, particularly across different sectors: the top quarter of companies have a default contribution rate of over 10 percent, and one in ten employers we surveyed offer over 16 percent.
There is less variation in employee contribution levels. Typical starting rates are between three and four percent of pensionable salary, although one in ten employers do not require employees to contribute at all.
Many employers by default enrol employees at the lowest contribution level, but 58% offer an additional company contribution match if employees contribute more.
The median additional matching company contributions range from an extra 3% to 6% from the lower to upper quartile.
More Focus on Outcomes
While 85 percent of respondents know what contributions employees and employers are paying into their scheme, just 35 percent could identify what employees can expect to receive at retirement – the same as our 2022 survey findings.
The lack of change here is disappointing. While few employees will spend their entire career with a single employer, it is still essential that companies understand the part their DC pension plays in helping employees save for an adequate retirement over time.
Most of those that have a handle on pension outcomes, (22 percent), use the Pensions and Lifetime Savings Association’s (PLSA) Retirement Living Standards to determine adequacy. Based on those measures, around half of respondents (48 percent) believe that their members will not be able to achieve a moderate standard of living in retirement (see graph). This figure may now be even higher as the latest PLSA figures show that expenditure needed for a moderate standard of living has increased from £23,300 to £31,300 for a single person.
Factors Affecting Adequacy
While contribution rates will always play a major role in retirement adequacy, there are other factors to consider. Employees often do not take full advantage of generous contribution matches from employers meaning that they lose out on a valuable workplace benefit offering a better retirement income in the future. Poor investment performance, high charges and bad choices at retirement can also significantly impact retirement adequacy.
People in financial distress may access their tax-free lump sum ahead of retiring from work – often between 55 and 60. Taking up to 25% of the value of a pension before retirement makes it harder to provide an adequate standard of living, so helping employees understand the wider implications of taking tax-free cash is also important.
Although the State Pension Age (SPA) has increased, many schemes still use 65 as a default retirement age. This could result in people struggling financially in the years between the default retirement age and when they start to receive their state pension. Amending scheme rules to align target retirement ages with the SPA could help to alleviate this.
Overall, our research found that most schemes do not know whether their contribution rates will deliver a moderate standard of retirement living based on the PLSA’s guidelines. Increasing company contributions may be seen as the obvious lever to improve adequacy, there are other ways that employers can improve retirement adequacy for employees. But unless action is taken to better understand the position for your scheme, it is impossible to know whether it is likely to deliver adequate retirement outcomes.
You can download a copy of Aon’s 2024 DC Pension Scheme Survey here