Today, people in the United Kingdom can expect to live longer than ever before. Increasing life expectancy, declining workplace pension participation and falling birth rates mean that, in the future, millions of people will face inadequate pensions in retirement. The UK government estimates that over seven million people are currently not saving enough to give them the income they want or expect.
In 2002, the independent Pensions Commission was set up to review the UK pension system and to make recommendations for change. The Commission recommended reforms that included enhancing the state pension system, raising the state pension age and increasing the level of private pension saving by introducing automatic enrollment of employees into a workplace pension. These recommendations achieved wide consensus and led to the implementation of an integrated package of reforms to help improve retirement outcomes in the future.
SO WHAT IS CHANGING?
Since October 2012, most employers in the UK have to enroll workers into a workplace pension scheme that meets or exceeds certain standards. These duties are being introduced over four years, with larger employers affected first. By 2017, employers will have to contribute a minimum amount; 3% of a jobholder’s qualifying earnings. This is added to tax relief and the jobholder’s contribution to give a total minimum contribution of 8% of qualifying earnings. Jobholders can choose to opt out.
NEST has been established to provide a low-cost scheme that any employer can use to meet their new workplace pension duties, and it will give many organizations and their workers access to a low-charge pension scheme for the first time. It is a trust-based defined contribution (DC) pension scheme. NEST has been specially designed for workers who don’t currently have access to a pension. The social policy aim is to make saving for retirement the norm and for it to be relevant to people’s everyday lives. I expect NEST to play a key role in helping to achieve that.
HOW DO THE CHANGES COMPARE INTERNATIONALLY?
Australia, New Zealand, Sweden and the Netherlands, among other nations, have all overhauled their workplace pension savings provision in the last 20 years. Many of these countries are facing similar demographic challenges to the UK and some have created a NEST-like scheme. However, country contexts are important, as one size does not fit all.
In Australia, employers are required to provide a scheme and enroll all workers. There is a compulsory employer contribution of 9%, and workers cannot opt out. Sweden has set up a body to administer, but not invest, funds – effectively operating as a clearing house. Employee contributions are compulsory, but there is no mandatory employer contribution. Featuring auto-enrollment and minimum employee and employer contributions, New Zealand’s KiwiSaver scheme is most similar to the UK reforms. Unlike UK pension savings, though, KiwiSaver can be accessed before retirement.
When compared globally, UK pension reform has three key features: automatic enrollment, which is not the same as compulsion, as workers can opt out; minimum contribution levels that fall within international ranges; and, third, the existence of NEST itself is a distinctive feature of UK pension reform as it specifically targets those new to pension saving. This is comparatively unique internationally.
WHAT ROLE WILL NEST PLAY?
It has been designed following detailed research, among both employers and potential future members. We have worked with employers to test our systems and processes to ensure they work for all kinds of businesses, and to reduce administration.
NEST has the potential to help millions who haven’t had a pension before
Employers have told NEST that they expect to use it in a number of ways, for example, as the sole scheme where there is no existing provision; alongside another pension scheme for a particular category of workers (defined by grade or salary); as an entry scheme where their existing scheme might have a waiting period; or as a foundation scheme as part of a wider benefits package. So it needs to be flexible in terms of how employers can use it.
NEST has also done lots of research on how we should communicate with people who aren’t familiar with financial terms and phrases. Our research showed that our potential members, and their employers, don’t like many of the words that a lot of us in pensions use every day. One example is the term “annuity.” When we explained that it meant a retirement income, they said, “Why can’t you call it that, then?” So we have. Similarly, NEST’s research on attitudes to investment means that our approach looks a little different from traditional approaches in DC schemes.
Our target group is more risk-averse than risk-seeking, with a large proportion (37%) favoring no risk whatsoever with their retirement savings. They had strong reactions to (even hypothetical) short-term investment loss, displaying emotions such as disappointment, anger, surprise and incredulity. Loss aversion is particularly strong among the young and those on low incomes. For its default fund – target-date funds – NEST has created different investment phases, including a foundation phase to provide a lower-risk start for younger members. At this age, our research shows that developing a savings habit and avoiding negative reactions to volatility (such as stopping saving) are key to retirement income prospects. You can’t generate a retirement income if you opt out!
The foundation phase (expected to last for around five years for a 22-year-old) will target inflation after charges to preserve the value of savings in real terms. By the age of 30 at the very latest, members will be in the growth phase with an objective of delivering CPI plus 3% after charges. The growth phase is the longest phase of most members’ saving careers and one where we will look to maximize investment performance while endeavoring to avoid extreme shocks. As members move closer to retirement, NEST aims to gradually reduce exposure to more volatile, return-seeking assets and invest in a way that best matches members’ planned method of taking retirement benefits. We call this phase “consolidation.”
NEST has the potential to help millions of people who haven’t had a pension before. We take that responsibility and challenge seriously, and, although our investment approach may be a departure from current DC pension fund investment strategies, we think it is right for our members. NEST is already working with a small number of volunteer employers who want to use the scheme ahead of the duties being introduced. It’s a very exciting time.