Unless many in the UK’s working population ramp up their pension contributions, they will face a poverty-stricken old age.
There is plenty of evidence to support this assertion and, without action, the situation will not change. Pensions auto-enrolment has helped spread the net, but too many are not saving enough in DC pensions, which are now the dominant type of pension fund in the private sector.
What can be done about this? CoreData’s latest report looks at several ways to make DC pensions more appealing to UK investors. These include offering alternative or esoteric investments, including some that are not currently permitted as pension investments, but others that are, along with ideas around reforming the rules on pensions tax relief and other ways to enhance the appeal of DC pensions.
The research, carried out among 500 UK investors in Spring 2021, put some numbers on important generational differences when it comes to pensions and investing. For example, 40% of the Millennial generation, aged between 25 and 40, would add cryptocurrencies to their pensions from a range of possible investments, if they could do so. In stark contrast, only 7% to 10% of the older generations (Generation X, Baby Boomers and the Silent Generation) would put cryptocurrencies in their pensions. The Silent Generation (aged 76 or older) prefer farmland or timber (27% vs. 19% overall), while Baby Boomers (aged 57 to 75) are more likely to select vegan products (19% vs. 17% overall).
How can DC providers use these results? Most DC investors are likely to contribute to a default fund, as very few DC members elect to make active investment choices. Default funds are designed to give investors the best chance of a comfortable retirement, by balancing risk and reward and gradually shifting individuals away from higher risk assets as they get older. This strategy is generally accepted as right for most people, but it means that DC members have little direct connection to their underlying investments. Auto-enrolment uses inertia to work, with individuals sleepwalking along what should be the right path for the average member.
One solution here could be to enable individuals to select one or two investments which appeal to them, as part of their overall DC fund. Having the option to invest in alternative assets, such as medicinal cannabis, or precious metals, could increase interest in pensions. Many younger investors have got into trading stocks during the pandemic, so being able to access a range of esoteric investments could spark more interest from them.
This approach would not be without risk. The regulator is almost certainly right to effectively prohibit cryptocurrencies from pensions at present, given their instability and the potential for fraud. But over time, if cryptocurrencies become an established asset class, this could change. And DC providers could already market gold and silver, frontier markets, medicinal cannabis, farmland, or timber as top-up investments for DC pension investors. If an individual’s main DC contribution into their default fund is the equivalent of the weekly shopping in a supermarket trolley, then a selection of esoteric investments could be the DC version of various special offers or impulse purchase items at the checkout. Creating interest with eye-catching investment offers could then lead to a broader conversation about pensions, investing and an individual’s retirement plans.
Another big generational difference is shown when it comes to encouraging pension contributions through tax breaks or other financial incentives for pension contributions. Overall, 36% of DC investors say the strongest incentive to increase DC contributions would come from a simple system of the government matching their contributions, so for the first, say, £10,000 that an individual contributes, the government matches this. This would be a major reform to pensions, as individuals currently get tax relief at the basic rate and also the higher rate, if they are a higher rate taxpayer. But such a radical move could be sold as ‘levelling up’ the pensions playing field.
But this is the strongest incentive for only 14% of Millennials. More than twice as many Millennials, 34%, say the strongest incentive for them to contribute more would be being able to borrow from a pension fund for any purpose, with the amount borrowed repaid at a low rate of interest. And for over a fifth of Millennials, allowing early withdrawals to help first-time buyers fund a property purchase would be the strongest incentive.
Clearly, for younger DC members, being able to access their pension fund earlier would be a strong incentive to contribute more. Arguably this would defeat the goal of retirement saving, as taking out money early on in the pension journey for borrowing or a house deposit could erode an individual’s eventual retirement income. But other countries allow early access in certain circumstances and UK pension minister Guy Opperman said he was looking at this issue last October. The findings show that something needs to change to incentivize many Millennials to contribute more to their DC pensions. Clever, creative ways of making pensions a vehicle for other financials needs, as well as retirement are needed. NEST is looking at a savings sidecar for instance, to allow members to build up emergency cash savings.
The Millennials have been called Generation Rent but they are also Generation DC. Making DC pensions more appealing to them will be important, so they contribute more and receive adequate retirement incomes. And for older investors, it may not be too late to up the contribution rate to their DC pension. Offering a choice of thought-provoking investments and building more flexibility into pensions could be two important ways to achieve this.