Make higher earners pay more into their pensions, says IFS

Employees as young as 16 and as old as 74 should automatically contribute to workplace pensions, while those on above-average earnings should be made to pay extra money into their nest eggs, according to a leading think tank. 

The Institute for Fiscal Studies (IFS) says the scope of auto-enrolment - which involves enrolling staff into pension schemes - should be widened to help avert a retirement crisis.

It recommends expanding the age range from 22 to state pension age to 16 to 74, while hiking the default contribution rate for those on higher salaries. The IFS suggests a 12% rate (compared to the current 8%) for earnings above £35,000.

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The report comes as chancellor Rachel Reeves prepares to unveil her first Budget next month. There is speculation that there could be changes to the pension tax relief system that make it less generous to high earners, in an attempt to plug the £22 billion funding gap that the Treasury says it inherited.

The government says it is also keen to boost pension saving and retirement outcomes, with pensions minister Emma Reynolds conducting a wide-ranging pensions review.

Jamie Jenkins, director of policy at the insurer Royal London, comments: “The nation is facing up to a ticking time bomb, with increasing numbers of people heading towards retirement with inadequate savings.  

“The government’s review of the pensions landscape is a rare opportunity to put us on a different trajectory; one that gives people confidence for the future and sets us on a more sustainable path for the economy over the long term. The Institute for Fiscal Studies has produced a thoughtful and well-researched package of recommendations, which should be seriously considered as part of that review.”

Auto-enrolment: reforms needed

Automatic enrolment has dramatically increased private sector employees’ participation in pension saving since it was introduced more than a decade ago.

Employers must automatically enrol employees who earn enough into a workplace pension if they are aged between 22 and state pension age, unless the employee opts out. The minimum contribution rate is 8% of the worker’s earnings, with them paying in 5% and the employer adding 3%.

But the IFS warns that many current workers are on track for “inadequate retirement incomes”, with between 30% and 40% of private sector workers - about five to seven million people - likely to fall short of what is needed for a minimum standard of living.

It says less than half of private sector employees who save into a workplace pension pay in more than 8% of their earnings, while low asset returns and increases in life expectancy make it harder for workers to build a nest egg big enough to deliver a comfortable retirement. 

The IFS says reforms are needed to boost pension saving; its proposals include the following:

• Increasing the age range targeted by automatic enrolment from 22 to state pension age, to 16–74, to help more people in paid work save for later life.
• Raising default employee contributions for people on average incomes and above. The current minimum contributions are 8% of earnings between £6,240 and £50,270. “Increasing contributions for those with low current earnings risks reducing take-home pay at a time in life when this can least be afforded,” says the IFS. “Increasing the minimum on the portion of earnings above a certain threshold would help some middle and higher earners better supplement their state pension. For example, there could be a 12% default total contribution rate for the portion of earnings above £35,000 (around median full-time earnings), with the additional contributions coming from employee contributions. Importantly, many on lower lifetime incomes who have higher earnings in some years would also be helped to save more for retirement.”
• Paying employees an employer pension contribution of at least 3% of total pay, irrespective of whether they contribute themselves. “This would benefit the 22% of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to their earnings being too low,” notes the IFS. “A risk would be that this leads to many more employees choosing to opt out of making an employee contribution. Although our reading of the evidence is that the numbers doing so would be small, a government more concerned about this could trial this suggested approach prior to implementation.”
• Raising the upper limit on qualifying earnings – which has been frozen at £50,270 since 2021–22 – at least for minimum employee contributions. “This limit makes it harder for some to make good saving decisions, and the real value of this limit has fallen significantly in recent years.”

Higher pension contributions for higher earners

Some experts have suggested increasing the default contribution rate from 8% to 12% for everyone. Earlier this month, Standard Life said hiking the auto-enrolment level to 12% could add more than £200,000 to a typical final pension pot.

However, the IFS argues that targeting those on above-average salaries - in other words, “helping employees save more at points in their lives when they might be more able to do so” - would work better.

It also suggests introducing an “opt down” facility, where employees who face the higher default pension contribution are given the choice to “opt down” to the minimum pension contribution rates currently in operation.

According to the think tank, implementing all of its suggestions would boost retirement incomes by between 12% and 16% (£1,400 to £2,100 per year) for those currently on track for low and middle incomes in retirement. But it would only reduce the take-home pay of lower earners by a small amount (probably less than 1% fall in take-home pay). 

In comparison, it says that moving all employees to minimum 12% contributions would boost retirement incomes but generate considerably bigger falls in take-home pay for low-paid workers.

David Sturrock, a senior research economist at IFS and an author of the report, comments: “It is really important to take seriously the affordability of asking for bigger pension contributions from many low-earning individuals, as well as the need for many to save more. We suggest a way forward that would focus the encouragement of higher contributions on periods of life when people have average, or higher, earnings.”

Jon Greer, head of retirement policy at Quilter, says the IFS’s proposed reforms “present a balanced approach to enhancing auto-enrolment”.

He notes: “Expanding the age range for automatic enrolment from 16 to 74 would help more people in paid work save for later life, ensuring that younger workers start embedding long-term savings as a social norm earlier, and older workers continue to build their retirement funds.”

Greer adds: “By targeting higher contributions on earnings above a certain threshold, such as £35,000, we can help middle and higher earners better supplement their state pension without unduly impacting those who can least afford it. However, there will be cohorts, such as those earners leaving university with large student loans, who may still feel this puts too much pressure on take-home pay.”