By Jo Thresher. Head of Money at Work, Jelf Group
Does auto-escalation work and does it improve retirement outcomes?
Before addressing whether auto-escalation works, the concept of auto-enrolment must first be considered. Automatic Enrolment was introduced because individuals were not saving enough into their pensions, and when it came to retirement they would be relying heavily on the State to support them in their life after work. Auto-enrolment relied on the idea that employees won’t make the effort to opt-out so they will stay enrolled and be saving without having to make active decisions. But that was only the first step. Most employers and employees are only contributing the minimum amount into employee pensions, and that’s just not enough. That is where auto-escalation comes in: employees agree to auto-escalation (or are enrolled and then have the choice to opt-out), then each year their contributions increase by an agreed percentage without them having to request the increase each time. Therefore, savings are increasing gradually, pension pots are growing and some employees will have enough to have the retirement they want. If this is the case, then auto-escalation does work.
But employers can’t guarantee that it will work for everyone. Many pension schemes in the U.S.A. have auto-escalation as a feature, and studies there have shown that participants tend to leave their contributions at the minimum1. Employees just aren’t engaged with their pension savings: they assume that auto-escalation means everything is taken care of, they are saving enough, and they can retire comfortably when they want. However, starting at the minimum contribution level and increasing slowly year on year takes a long time to get to the suggested percentage that individuals should be saving at, if it reaches that level at all. The assumption that auto-enrolment and auto-escalation rates are optimal means that they do not and will not work for most people.
The minimum contribution level under auto-enrolment is 5% for employees and 3% for employers: 8% in total. But 8% of a lower salary can be vastly different to 8% of a higher salary – there is a discrepancy between the level of savings of higher and lower earners. This means that personal circumstances need to be taken into account when discussing pension savings, and that means employees need to be engaged and making active decisions that work for them. A report by the Pensions Policy Institute2 found that the probability of an employee achieving their target retirement income changed with their earnings level. The probability for an employee to achieve their target was 63% for lower earners, IF they started saving at 22, IF they retire at the state pension age and IF they follow a “traditional investment approach”. But we need to consider those employees who don’t start saving at 22, which unfortunately, even with the introduction of auto-enrolment, is still the majority of individuals.
Therefore, retirement outcomes for employees are only improved by auto-escalation if the pot they get at retirement is what they need. Auto-escalation can’t guarantee that, it only does part of the job. Employees need to know how much they need in retirement before they know how much they need to save. There is the assumption that minimum contribution levels and gradual increases in salary result in a good retirement, but if it’s not enough for one person then it doesn’t work. Auto-escalation cannot provide good retirement outcomes for everyone.
Negatives of auto-escalation and loss of engagement
Auto-escalation is based on inertia: the idea that employees are too confused, too busy or simply not interested in their pensions. Once they are enrolled, it is unlikely that the majority will opt-out. Employees may feel that being auto-enrolled and agreeing to auto-escalation means they don’t need to do anything else, and so they become disengaged. If employees assume they are on track for a good retirement outcome, it could be too late before they realise that they haven’t saved enough. When they do realise, they are going to be seeking help from their employer, asking why they weren’t warned.
Many employees also struggle with their finances: 2.9 million people in the UK are in problem debt3 and 1 in 5 people have no savings4. If employees are worrying about debt and a lack of savings, Pensions are likely to take a back seat as they are not seen as something that exists in a person’s current situation – they are a distant prospect sometime in the future. Even if employees are saving into their pensions and increasing their contributions gradually, other life events that have an impact on their finances could take precedence, such as mortgages and childcare. Getting employees engaged with their pensions and making active decisions from the start of their working lives gives them control and they can increase (or decrease) their contributions when they need to. Providing support to employees with wider financial issues also allows them to understand their finances, be better with their money and understand the importance of saving for their retirement.
Communicating to employees about auto-escalation and practical solutions to increase engagement
Auto-escalation can be communicated to employees in the same way as any other workplace communication. However, as we know, emails and reminders don’t always work – employees may not read them, may not understand them or may forget them.
When it comes to Pensions communication, there is a basic level of understanding needed to provide a foundation for employees to build from and to realise the full impact of issues like auto-escalation. Employers need to think about why their employees would commit to auto-escalation if they’re not already engaging with their pensions. It’s likely that employees don’t understand the importance of saving and what a percentage of their salary actually gets them in retirement. Furthermore, employees who want to retire early, want to travel or take up expensive hobbies are likely to need more savings to be able to do those things, but they might not realise that. The key is to plan all of this in advance.
We believe that communication strategies around auto-escalation need to include face-to-face education in order for individuals to fully understand the impact auto-escalation will have. It is a single part of a much bigger picture, all of which needs to be addressed. There should be a continuous conversation between employers and employees throughout the whole of their careers so that employees can plan accordingly and discuss their retirement openly. Discussions will be more relevant and absorbed by employees if the basic understanding is in place. This enhances the message of the importance of saving and this leads naturally into the conversation about auto-escalation. Face-to-face financial education on Pensions opens the door to understanding and allows individuals to become engaged with their retirement planning.
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