Before starting to think about incentives to save into the pensions system, it must be remembered that the UK state pension is far from generous. At £164.35 a week, the new single-tier pension is little more than half a week’s income on the national living wage rate of £7.83 an hour.
The state pension is supposed to be a platform on which other savings can be built because additional savings need to be considered to ensure a comfortable retirement income. However, long-term saving is hardly popular. It means locking money up for decades and trusting the financial services industry to invest it soundly. Hence the need for additional incentives.
For employees, the biggest incentive is that the employer pays in as well. The minimum level under the auto-enrolment regime, once it is fully implemented from April 2019, is for the employer to contribute £3 for every £4 the employee puts in. This is a big advantage for employees, compared with the self-employed.
The other important incentive is the tax rebate, which adds 25% to the contributions of a standard-rate taxpayer. For higher-rate taxpayers, the relief is so generous that the government has been rowing back on how much higher earners can squirrel away.
The government is considering re-branding the amount it provides as a ‘top up’. Ideally, it would implement a flat rate that would raise the incentive for the bulk of savers, who earn less than the £46,351 threshold for paying higher-rate tax. This could be covered by a related saving on tax rebates for higher earners.
Pension funds approved for the auto-enrolment regime have caps on charges and a set of governance rules to protect savers. The key to long-term investing, as opposed to putting the money into instant-access savings accounts, is that it can be invested in assets such as shares, which are risky in the short-term, but deliver better returns in the long run.
So, not only are the incentives for saving into a pension sufficient, but employees would be unwise to turn them down.
Jane Fuller is co-director and pensions fellow at the Centre for the Study of Financial Innovation