Pension contribution rates should be automatically increased in line with pay rises, according to research warning that UK savers are missing an important opportunity to boost their retirement income.
Less than 1 per cent of private employees increased their pension contribution rate in response to a 10 per cent pay rise, according to the Institute for Fiscal Studies, a think-tank.
Older employees with higher disposable incomes, who were likely to have lower spending commitments as a result of paying off their mortgage or no longer having to incur childcare costs, put themselves at a disadvantage by failing to bolster their pension pot.
“When people do have extra cash available, either because of a pay rise, paying off their mortgage or their children leaving home, very few employees put any of this extra cash into their pension,” said Laurence O’Brien, an economist at the think-tank.
High earners and empty nesters may be in a position to increase their pension contributions, as employees received larger than usual wage increases last year in response to rising inflation.
In a report on Friday, the IFS said that it had not observed a significant increase in pension participation or contribution rates among higher-rate taxpayers since the introduction of auto-enrolment a decade ago.
Researchers also said that there was little evidence of people changing their pension savings at a particular “trigger age”. However, they identified a 0.4 per cent increase in contributions when people moved from renting to having a mortgage, and a 0.3 per cent reduction among parents on the arrival of a first child.
The IFS proposed greater minimum employee contributions for high earners, or an “auto-escalation” where default contribution rates rise in line with wage increases. It said this would nudge people into making better decisions which would help “smooth their living standards over the life”.
The proposals were welcomed by pension providers. Gail Izat, managing director for workplace at Standard Life, said that auto-enrolment had shown that “inertia is a powerful force”, and one way of addressing this was automatic increases to people’s contribution rates.
Mark Futcher, partner at pension consultants Barnett Waddingham, said people needed to be saving around 12 per cent of their annual income into their pension pot, and most were far below that even accounting for employer contributions.
“Much of this is driven by employees staying at the contribution levels they are entered into when they start work, so when their pay rises, the contribution amount goes up but the percentage rate stays static,” he said.
The IFS analysed data from the annual survey of hours and earnings between 2005 and 2012, and between 2019 and 2020. In both periods, they observed that changes in earnings had a small effect on pension participation.
The think-tank also found high earners only responded mildly to changes in upfront tax relief on pensions, with a one percentage point fall in pension participation among those earning £60,000 in response to a cut in relief from 40 per cent to 20 per cent.
“This research shows just how much people’s retirement savings behaviour is shaped by decisions taken for them, not by them,” said Tim Gosling, head of policy at provider the People’s Pension. He said attitudes were strongly influenced by automatic enrolment and the generosity of workplace pension schemes.
This month, the IFS said pension pots should be subject to inheritance tax and recommended new limits on tax-free lump sums as it argued in favour of measures such as relief from national insurance contributions on pension contributions in exchange for NICs on private pension income.
At the time, the think-tank argued that proposals would favour the lowest of earners and enable the Treasury to relax limits on both the annual and lifetime allowances, which have been subjected to cuts since 2010.