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18 March 2019

Auto-enrolment for pensions is a behavioural economics success – but will it stay that way?

Emma Stockdale and Dr Michael Sanders

EMMA STOCKDALE and MICHAEL SANDERS: An increase in employees' default pension contribution could have unwanted effects

Piggy bank

Behavioural economics has scored some notable victories in recent years, but the biggest of these is almost certainly the decision by the UK government to become the first country to institute automatic enrolment for pensions – so that employees save for retirement through their employer “by default” unless they explicitly opt not to. The policy, based on the research of American economists like David Laibson, Brigitte Madrian, Jon Beshears and James Choi, has increased the proportion of people saving for retirement by 29%.

While employees of large companies have been automatically enrolled into pensions since 2012, last April saw the first increase to the minimum savings rate, taking employee contributions from 1% to 3%. Many predicted that this pretty substantial increase would lead large numbers of people to opt out, potentially reducing overall savings rates. In fact, there was little change in opt-out rates, and people have saved an estimated £6.4 billion extra as a result.

It’s easy to assume that there might be similarly small effects when employee contributions rise from the current 3% to a slightly more daunting 5% in April. For many higher earners the effect might be small in relative terms, but there are concerns that for lower earners, who already face significant financial pressures, this impact may be too large to bear, leading to many opt-outs by people who stand the most to gain by increasing their retirement savings.

However, the impact for these people may not be as significant a change as it seems on first glance. The behavioural economists Richard Thaler and Schlomo Benartzi invented a tool to encourage retirement savings called “Save More Tomorrow” (SMT), through which people could opt to increase their retirement savings rate gradually over time, rather than experiencing the shock of a sudden increase. SMT was a huge hit, with most people signing up to it (compared to almost nobody signing up for high savings rates immediately).

Something like SMT exists in the wilds of the British tax system. At the same time as the default saving rate is increasing, so too is the personal allowance – the amount most people can earn before having to pay income tax – by £650, saving the average basic-rate taxpayer £130. The minimum wage is also increasing by 4.9%. Taken together, these two effects work against the increase in the savings rate – meaning that many people, even on low incomes, may start saving more for their retirement, without feeling any pain in their pay packet.

Some people will doubtless decide that the price of 5% is too steep, and will change their savings rate. What remains to be seen is what those people who could stomach a 3% rate but not a 5% rate will do. Will they change back to 3%, or opt out altogether? If the latter, then behavioural economics’ biggest success to date risks unravelling just as it starts to be truly impactful.

Emma Stockdale is a PhD student in the Department of Political Economy, and Michael Sanders is Reader in Public Policy at the Policy Institute, both at King’s College London.

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