Amounts and Accounts: Reforming Private Pension Enrolment Carl Emmerson and Matthew Wakefield Institute for Fiscal Studies © Institute for Fiscal Studies

IFS Retirement Saving Consortium Association of British Insurers Bank of England Barclays Chartered Institute of Personnel and Development Department for Work and Pensions Financial Services Authority HM Revenue and Customs HM Treasury Investment Management Association Pensions Regulator Personal Accounts Delivery Authority Scottish Widows The Actuarial Profession © Institute for Fiscal Studies

The 2012 pension reforms and private pension holding in the UK Carl Emmerson © Institute for Fiscal Studies

State pension reforms Pension Credit Guarantee to be indexed to earnings-growth Increased generosity of basic state pension State Pension Age increased from 65 to 68 between 2024 and 2046 Reduced generosity of Pension Credit Savings Credit Reduced accrual of State Second Pension for higher earners Impacts: –increased income from state for many from State Pension Age –state support less targeted on lower-income pensioners –simpler pension system © Institute for Fiscal Studies

2012 private pension reforms Employers to enrol employees automatically into a private pension which complies with certain minimum standards –all employees aged between 22 and State Pension Age earning more than £5,035 (in 2006–07 earnings terms) Compliant schemes include: –contracted-out defined benefit arrangements –defined contribution schemes with certain minimum contributions (includes new Personal Accounts) No increase in compulsion for employees –free to choose to leave the scheme –re-enrolled each time they move employer and might also be re- enrolled periodically (but not more often than every 3 years) © Institute for Fiscal Studies

Personal Accounts A new pension option for employers –minimum default contributions of 5% of band earnings from employee (1% being basic rate income tax-relief) and 3% from employer –applies to earnings from £5,035 to £33,540 (2006–07 earnings terms) Employees can choose: –to contribute less than the default minimum, but would risk losing the employer contribution; or to contribute more than the default amount Employers can choose: –to have a higher employer contribution; or to enrol employees at higher default employee contribution rates Annual contribution cap of £3,600 (2005 earnings terms) In most cases no transfers between Personal Accounts and other private pensions (review in 2017) © Institute for Fiscal Studies

Reforms to boost private pension coverage Those currently not choosing to join an employer’s pension scheme: –standard economic model: slightly easier to contribute to a private pension and slightly harder not to contribute to a private pension –behavioural economics: some individuals might shy away from making seeming complex decisions © Institute for Fiscal Studies

Changing defaults can boost pension coverage… © Institute for Fiscal Studies Source: This graph has been used in presentations by David Laibson (e.g. Laibson, 2008); it draws on and is sourced to Choi et al. (2004), which in turn built on Madrian and Shea (2001).

…but some might contribute less © Institute for Fiscal Studies Source: Madrian and Shea (2001).

Reforms to boost private pension coverage Those currently not choosing to join an employer’s pension scheme: –standard economic model: slightly easier to contribute to a private pension and slightly harder not to contribute to a private pension –behavioural economics: some individuals might shy away from making seeming complex decisions Those currently not offered the chance to join an employer scheme will face an increased incentive to join a private pension –employer contribution of (at least) 3% of (band) earnings is contingent on the employee not choosing to leave the scheme –in addition to impact of change in defaults © Institute for Fiscal Studies

Private pension coverage in the UK © Institute for Fiscal Studies Source: Authors’ calculations using data from the FRS and the BHPS.

Detailed pension status, 2005 © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by earnings, 2005 Median earnings among those not contributing to private pension was £14,000 compared to £21,600 among those who did –increase in private pension coverage to be associated with only a small, at least in absolute terms, increase in contributions © Institute for Fiscal Studies

Pension coverage by earnings, 2005 © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by liquid assets, 2005 Those not contributing to a private pension are not more likely to have gross debts, or greater gross debts, than those who are © Institute for Fiscal Studies

Pension coverage by non-mortgage debt, 2005 © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by liquid assets, 2005 Those not contributing to a private pension are not more likely to have gross debts, or greater gross debts, than those who are But they are less likely to have savings/investments to offset debts © Institute for Fiscal Studies

Pension coverage by liquid assets, 2005 © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Average liquid assets, by detailed pension status © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by liquid assets, 2005 Those not contributing to a private pension are not more likely to have gross debts, or greater gross debts, than those who are But they are less likely to have savings/investments to offset debts Suggests they should be saving more but not in a private pension? Limited scope for those brought into private pensions to use other savings or investments to finance contributions –more likely that new pension saving will be new overall saving –individuals brought into private pensions might pay off existing debts less quickly © Institute for Fiscal Studies

Pension coverage by other characteristics Within couples pension status is positively correlated –but many not contributing to a private pension have a partner who does © Institute for Fiscal Studies

Pension holding within couples © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by other characteristics Within couples pension status is positively correlated –but many not contributing to a private pension have a partner who does Pension coverage lower among those aged 22 to 29 –21ppt less likely to be currently contributing than those aged 40 to 49 –less likely to accept offer to join an employer’s pension scheme, and less likely to arrange an individual private pension –how might this change as they age? © Institute for Fiscal Studies

Pension status by age © Institute for Fiscal Studies Source: Authors’ calculations using data from the 2005 BHPS.

Pension coverage by other characteristics Within couples pension status is positively correlated –but many not contributing to a private pension have a partner who does Pension coverage lower among those aged 22 to 29 –21ppt less likely to be currently contributing than those aged 40 to 49 –less likely to accept offer to join an employer’s pension scheme, and less likely to arrange an individual private pension –how might this change as they age? Coverage higher among public sector workers –26ppt more likely to be currently contributing than private sector workers –more likely to be offered chance to join an employer’s scheme and, if offered, more likely to accept an offer © Institute for Fiscal Studies

Conclusions Reforms to enrolment and default contributions to boost private pension coverage Most not currently contributing to a private pension have lower earnings –pounds increase in contributions will be small Majority not contributing to a private pension do not have positive liquid wealth –reshuffling small but some to repay debts less quickly? –is a pension the best savings vehicle for them? Those aged 22 to 29 are less likely to be contributing than older individuals –a key issue is how their behaviour will change as they age © Institute for Fiscal Studies

The market for Personal Accounts Matthew Wakefield © Institute for Fiscal Studies

Outline for part 2 How much current disposable income would those not currently contributing to a private pension forego if they were to contribute 5% of their earnings in the band £5,035 to £33,540? How many not currently offered an employer pension might be brought into private pensions – perhaps often Personal Accounts – through the change in enrolment? How much might these individuals build up in pensions through minimum default contributions? © Institute for Fiscal Studies

How much disposable income foregone? Take the most recent available year of data on incomes, pension contribution status and family circumstances –FRS, 2006/07 Change pension contributions such that all those not in fact contributing to a pension make individual contributions of 5% on the on the band between £5,035 and £33,540 of earnings Model how this affects current disposable income, given the tax, benefit and credit system. Look at effect on average across the population, and also at how this varies across the income distribution © Institute for Fiscal Studies

Income devoted to employee contribution Contribute a proportion of a band of earnings –A key determinant of income taken is level of earnings Take an individual earning £33,540 with no other income –Contributes 0.05*(33,540 – 5,035) = £1,425 –20% is tax relief, reduction in income: 0.8*£1,425 = £1,140 –This is 3.4% of the £33,540 gross income –Disposable income – net of income tax and NI – would have been £24,561 w/o the pension contribution –£1,140 is 4.6% of disposable income This is the biggest ‘loss’ somebody could have –No interaction with higher-rate income tax or benefit withdrawal –Lowest income on which one could pay 5% of the whole band © Institute for Fiscal Studies

Income devoted to employee contribution Take an individual earning £7, (one-tenth of the way from £5,035 to £33,540) with no other income –Contributes 0.05*(7, ,035) = £142.5 –Contribution less tax relief is £114 –This is 1.4% of gross income, 1.6% of disposable income Take an individual earning £60,000 with no other income –Contributes 0.05*(33,540 – 5,035) = £1,425 –40% tax relief, reduction in income: 0.6*£1,425 = £855 –This is 1.4% of gross income, 2.1% of disposable income Level of earnings a major determinant of proportion of disposable income accounted for by contribution © Institute for Fiscal Studies

Income devoted to employee contribution Level of earnings a major determinant of proportion of disposable income accounted for by contribution Amount of non-earned income will also matter –Contribution a proportion of earnings –No extra contribution for “other income”, but it is extra disposable Example of higher-rate taxpayer also showed tax-rate matters –This is effective tax-rate, not just a distinction between basic- and higher-rates –Similar effect for those on steep taper of new tax credits –For such an individual, at least some of pension contribution “costs” only 41p of disposable, per pound of contribution, thus reducing the proportion of disposable that is foregone © Institute for Fiscal Studies

Proportion of disposable accounted for by 5% employee contribution from those not currently contributing Among families containing an “affected” individual Source: IFS Tax and Benefit model, TAXBEN, using data from 2006–07 Family Resources Survey.

Proportion of disposable accounted for by 5% employee contribution from those not currently contributing Across all families Source: IFS Tax and Benefit model, TAXBEN, using data from 2006–07 Family Resources Survey.

Proportion of disposable accounted for by 5% employee contribution from those not currently contributing Across all families Source: IFS Tax and Benefit model, TAXBEN, using data from 2006–07 Family Resources Survey.

How many might be automatically enrolled into Personal Accounts? Examine one group who might have been enrolled into Personal Accounts in the past –Those not offered employer’s scheme Excludes any whose employer might choose Personal Accounts when previously offering a different scheme Also supposes employers that did not offer pension scheme in the past would now offer Personal Accounts Think of the group identified as a group: –Relatively likely to be brought in to Personal Accounts –Who would be new to being offered pension through the workplace Use BHPS data –Baseline year 2005, but also look at evolution © Institute for Fiscal Studies

Personal Account defaultees? © Institute for Fiscal Studies

Personal Account defaultees? © Institute for Fiscal Studies

Personal Account defaultees? © Institute for Fiscal Studies

Personal Account defaultees? © Institute for Fiscal Studies

Persistence of being in PA default group © Institute for Fiscal Studies

Amount of default minimum contributions How much would the group identified in 2005, have contributed over the period 2001 – 2005 Default minimum contributions are 8% of earnings between £5,035 and £33,540 so can be computed straightforwardly –Assessing actual contributions would be much more complex The amounts will be a reflection of the earnings distribution … and of how this and group membership shifted over the period , for those identified in 2005 © Institute for Fiscal Studies

Distribution of PA default minimum contributions © Institute for Fiscal Studies

Averages of PA default contributions © Institute for Fiscal Studies

Averages of PA default contributions © Institute for Fiscal Studies

Conclusions (1) Reforms to enrolment and default contributions to boost private pension coverage Most not currently contributing to a private pension have lower earnings –Pounds increase in contributions will be small Majority not contributing to a private pension do not have positive liquid wealth –Reshuffling small but some to repay debts less quickly? –Is a pension the best savings vehicle for them? © Institute for Fiscal Studies

Conclusions (2) Default minimum employee contribution to reduce disposable income by 0.5% Number brought in to Personal Accounts likely to increase quickly –Although also a persistent group of defaultees –Some would have saved in a private pension without the reform Among those not offered an employer’s pension scheme in 2005: –Aggregate contributions £4.2 billion from 4.7 million individuals –Median contributions of £770 –Over , median contributions of £2,170 © Institute for Fiscal Studies

Amounts and Accounts: Reforming Private Pension Enrolment Carl Emmerson and Matthew Wakefield Institute for Fiscal Studies © Institute for Fiscal Studies