The defined contribution (DC) pension affordability gap means many employees may not be able to afford to retire at the age they would prefer. With no UK default retirement age, promotion opportunities and succession could grind to a halt.
So what can, or must, employers do in response to the mounting DC crisis, to give employees the best chance of achieving a reasonable income in retirement?
Historically, employers have not been legally required to provide for, or even take much interest in, members’ DC outcomes beyond providing access to a stakeholder scheme, although, of course, many employers do much more than this. However, DC regulation is evolving quickly, particularly in relation to contributions and scheme design.
The auto-enrolment regime requires employers to make pension contributions on behalf of each employee enrolled, but this is not a complete answer to the DC gap. Even when the regime is fully in force from October 2018, the minimum requirement will be less than the current average contribution rate.
Many employers are considering ‘smart’ strategies for increasing contributions to a more appropriate level, such as auto-escalation (whereby staff agree in advance that, at a particular date or salary level, they will increase the percentage they pay in) and matched or incentivised contributions.
Employers must also work with trustees and providers to ensure contributions are paid to the scheme correctly and on time, and must comply with information and record-keeping duties.
The Pensions Regulator has provided guidance on what employers should look for when selecting a scheme for auto-enrolment. Charges can dramatically reduce a member’s retirement savings, so the government intends to introduce caps on default fund charges.
The vast majority of members use default funds rather than making active investment choices, so it is vital to get the design of these strategies right. The government also plans to introduce minimum standards for default fund design and governance.
Whatever new or existing scheme an employer uses, it must provide value for money, comparing the charges deducted from members’ DC pots with the quality of the overall product.
The regulator is also encouraging employers participating in either a group personal pension or a master trust arrangement to take a more active governance role by introducing employer management committees.
Key elements of good DC outcomes hinge on member choice, so encouraging member engagement is vital. Increasingly, employers are supporting innovative communication campaigns to highlight the importance of saving for retirement and choosing appropriate investment options.
Employers are sometimes wary of appearing to give financial advice and may find the regulator’s guidance on what should, can and cannot be said about pensions a useful resource.
The battle is on to improve member outcomes by improving DC structures, through encouragement and best practice, and by force, if necessary, through the imposition of minimum standards.
Employers have an important role to play, which, in the longer term, they cannot afford to ignore.
Helen Powell is senior professional support lawyer (pensions) at Allen and Overy