Auto-enrolment begins next October, with the aim of increasing the retirement income of a large proportion of the 14 million UK employees who do not currently save in a workplace pension scheme.
An estimated nine million people will join the Government-sponsored National Employment Savings Trust, but millions more could opt straight out of the system unless HR finds an effective way of communicating how it works and why saving for retirement is important.
Failure to save is largely down to a number of psychological and physical barriers, which HR departments must ensure that they fully understand before they being able to help employees address and overcome them.
Assess affordability
Rocketing inflation combined with pay freezes have forced many UK households into financial hardship recently, making it difficult to find spare cash for pensions. While initially, employee contributions to NEST will equate to just 1% of gross salary, the figure rises to 4% unless employers contribute more than the minimum.
This 1%, in turn, equals a net ‘loss’ of £70 a month for the average employee earning £26,000 a year.
Over time, however, increases to employee contributions will be phased in and amount to more like 5% of gross salary (4%, with a further 1% tax relief being added). The employer minimum will be 3% of each employee’s eligible earnings, meanwhile, taking the overall minimum total to 8%.
What this means is that it is important for the HR department to fully explain this ‘phasing in’ aspect of NEST as well as the consequences for individuals of opting out.
Boost financial understanding
A lack of financial proficiency prevents many employees from planning for future events, whereas access to education enables them to make more informed decisions. As a starting point, therefore, it may be helpful to encourage staff to calculate how much they might need for retirement.
Workshops and online learning resources can then help them understand how they might be able to budget more effectively and identify areas that could be cut back on in order to free up cash for pension saving.
Providing employees with information tailored to their own individual circumstances is likewise highly effective. Financial tools and examples should be used to show people both how much NEST membership will cost them personally and what an estimated value of their savings at retirement would be.
But it is important that HR professionals are clear and comprehensive about the contribution situation because of the potential damage caused by appearing to surreptitiously deduct contributions from employees’ salaries.
NEST education
The overall pension scenario is not helped by the fact that products are typically extremely complex, which generates off-putting levels of confusion. But this state of affairs can be remedied via education about how investments are structured, how tax relief works and an explanation of the effects of compounding – a phenomenon that Einstein called the eighth wonder of the world.
A study by HSBC found, for example, that, while 67% of low-income respondents (those earning less than £18,000) were not aware of NEST as a concept, most were very keen on the idea once it was explained to them.
The need for self-reliance
It’s a common misconception that the state will provide enough money for people to live on, yet too many who believe this are not aware of how much the state pension amounts to. The question becomes, however, if it were a generous benefit, why are two million pensioners currently living in poverty?
But HR professionals can help by supporting staff in working out their projected state pension and identifying any discrepancies between what it actually is and what they would like it to be. It is also important to ensure they understand that state pension provision could change dramatically in future and that the state pension age is due to rise, which means that it might no longer match their planned retirement date.
Explore alternative options
Some individuals prefer to use alternative methods to save for retirement such as contributing regularly to ISAs or treating rent paid on a second property as pension income. Although there is nothing wrong with this approach, it is important that workers are aware of all of the pros and cons.
Pension contributions, for example, are subject to tax relief, while ISA contributions are not, but only 25% of the income from a pension is tax-free, whereas it amounts to 100% for an ISA.
Psychological barriers
There are psychological barriers to pension saving, which can prove more difficult to overcome. Most people place more value on a reward gained today than a future benefit, for example.
Even though many younger employees believe that retirement is too far away to worry about just yet, starting early is one of the key principles for success. A 20-year-old who consistently contributes 10% of their income to a pension pot will achieve roughly the same retirement income as someone who starts at 40 by putting 30% into theirs.
But older employees are also often reluctant to start saving for retirement, feeling that they have already missed the boat. In practice, however, people can contribute to pension schemes until they are 75, although the fact that late saving can affect pension credits and other state benefits should be taken into account.
But asking employees to imagine themselves as pensioners can help encourage them to save. By visualising their ideal future situation, they are better able to calculate how much money they might need, which can contribute to easing any fears or denial about growing older.
Reduce risks
Issues of trust issues are likely to be the most difficult barriers to overcome, however. The challenge is that NEST involves both the financial services sector and government and the vast majority of the public trusts neither.
Moreover, because a stock market crash can wipe billions of pounds off the value of pension funds almost instantaneously, many people are afraid to invest their hard-earned cash in such an apparently risky venture.
But it is worth pointing out that, while equity investments are notoriously volatile in the short-term, they have consistently outperformed other asset classes over the longer term. Although this might not always be the case and past performance does not dictate future performance, individuals with a low risk tolerance could be advised to choose other options.
NEST offers a number of different investment choices, which HR departments should take time to explain properly so that individuals can make more informed choices about where to put their money.
A final consideration is that employees no longer have to retire at the official state retirement age, but can delay it, or phase it in, in order to give their investments longer to accrue value – although there is always the risk that they may decrease in worth too.
Without adequate retirement savings, however, staff have only two options: work until they drop or risk pensioner poverty by relying on state-supported retirement benefits. Putting money aside on a regular basis, on the other hand, at least provides them with a few more choices.
Lauren Peters is head of financial education at financial education provider, Money in Mind.
