Need to know:
- Setting differing contribution levels within a workplace pension arrangement allows employees to select what they can afford to put aside for their retirement.
- Benchmarking against other organisations within the same industry enables employers to set a sector-competitive pension contribution structure.
- Employers with a paternalistic outlook could consider setting a higher minimum contribution level to help staff achieve their desired retirement outcomes.
All employees will have an idea in mind of the lifestyle they wish to have in retirement. For many, however, their dreams will remain exactly that, with retirement pots failing to provide sufficient income to fulfil their plans.
According to The Pensions Regulator’s Declaration of compliance report, published in January 2017, 7,165,000 eligible job holders were automatically enrolled into a pension scheme as part of the auto-enrolment process up to December 2016. So with more employees now members of a defined contribution (DC) workplace pension scheme post-auto-enrolment, how to design and implement a contribution structure to positively impact employees' retirement incomes is a challenge for organisations.
Contribution structures
Matching contributions is one of the most common types of contribution structures. The employer will contribute a set percentage into an individual’s pension scheme depending on the level that the employee contributes. Matching can be done on a one-for-one, two-for-two or a double-match basis, or up to a set maximum level.
Matching structures are now often implemented across two levels; one at the auto-enrolment minimum and one at a higher rate for employees who wish to contribute more into their pension pot.
Other structure types include a non-contributory approach, where the employer pays both the employee and employer minimum contributions, usually as a way to minimise staff opting out of the scheme. However, these may not always be as effective at engaging staff with pension saving as matching contribution scheme, says Mark Pemberthy, proposition director, benefits consulting at JLT Employee Benefits.
"In a non-contributory pension scheme, the employee is getting free contributions [and] there’s a risk that they don’t value them as much than if they are having to pay a little bit," he says. "So I think it’s [about] greater awareness and greater actual value on contributions compared to non-contributory pension schemes, where potentially there is a risk that they just get taken for granted.”
In order to find the middle ground and ensure contribution levels are affordable for staff, some employers have reversed the minimum contribution levels required under auto-enrolment so the organisation pays the higher of these. Dale Critchley, pensions technical manager at Aviva, explains: "I was involved with a retailer, which made the decision that it would reverse the employer-employee contributions that were due [under] auto-enrolment, so rather than the employee having to pay 5% and the employer 3%, it would change that so the employee paid 3% and it would pay 5%. That [was due to] the corporate culture."
Contribution structures can also be based around length of service, pay, or seniority within the business, however, these have seen a fall in popularity “Those kinds of designs don't really sit with the way that most organisations reward their employees,” says Pemberthy. "We see more organisations moving towards a flat hierarchy of benefits where everyone gets the same irrespective of seniority. From a communication and fairness point of view, that can be a really strong message from the employer.
Business advantages
Getting contribution structures and levels right can deliver a return on investment for employers. For example, employees who opt for a higher matching contribution level to take advantage of the increased employer contribution are likely to be more engaged and value their pension as a benefit. Tony Britton, head of DC solutions at Aon Hewitt, says: "It helps get people engaged. The disengaged don't use the [organisation's] spend, so from [an organisational] point of view, it can make some sense.
As well as boosting retirement outcomes and staff retention, enabling staff to increase their contributions beyond either the auto-enrolment or scheme minimum can increase employees' engagement with their pension, because they have the opportunity to make active decisions around their contribution levels.
An attractive contribution structure can also be used as an recruitment tool. Alan Ritchie, head of employer and trustee proposition at Standard Life, says: “Pensions is one of the benefits levers [employers] can pull to try and attract [a particular] type of audience to [the] business.”
If the pension scheme can help staff to reach their target retirement outcome, this can build loyalty and help to position the organisation as a great place to work.
Competitive sector benchmarking can also be used to determine the right contribution structure and level for an organisation. Often, employers in the same sector will use pension arrangements as an attraction and retention tool for the same pool of employees. Benchmarking will typically be carried out by a consultancy or using industry data.
However, some organisations are now adopting a best-of-brand approach to benchmarking, says Aon Hewitt's Britton. This involves organisations benchmarking against premium or aspirational brands, rather than those within their own industry, to utilise ideas on benefits from other sectors. Benchmarking against brands that employees know and trust can be a positive message to give to staff, however, it could also lead to a higher benefits spend than may be typical within a specific organisation's sector.
Contribution structures can vary between sectors. Dale Critchley, pensions technical manager at Aviva, says: “If the sector is offering a [professional] career, [employers] will be more concerned about the attraction and retention of staff until a later age and, therefore, will offer generally higher contribution rates than sectors that traditionally have a higher turnover of individuals or a much younger workforce.”
Considering contributions
When setting pension contribution rates, employers should take into account factors such as industry benchmarking standards, what the organisation and individuals can afford to contribute, and how the organisation views its pension scheme, for example, is it viewed as an asset to attract and retain staff or more as a cost to be borne? This could influence whether employers promote minimum levels of contribution under auto-enrolment or opt to set levels above the minimums required.
Employers should also consider factors such as creating an adequate retirement provision for staff, workplace union influences, feedback from staff focus groups and other benefits that staff may value alongside a pension. Britton adds: "The employer might not try to be the 'best payer' but aim to be paternal, giving employees a great package that recognises their long term needs."
The importance attached to deciding what percentage to set as a scheme's minimum contribution level should not be overlooked. Human nature means a number of employees will inevitably default to this level, so ensuring it is adequate is vital. Lee Hollingworth, partner and head of DC consulting at Hyman Robertson, says: “We have to watch out for the power of inertia. Employees find pensions quite complex and it’s difficult to get them away from wherever they’re defaulted to. The power of default is so important.”
Employers that want to take a paternalistic approach to pensions, for example, could set a scheme's minimum contribution level above that required under auto-enrolment to help staff achieve a better retirement income.
As a result of the auto-enrolment contribution escalation that is due to take place during 2018 and 2019, some employers may decide to start changing their contribution structures now. This would result in a more gradual increase so employees can step up their contributions at a slower, more affordable pace. The mandatory changes include an increase to 3% employee contribution and 2% employer contribution between 6 April 2018 and 5 April 2019, followed by an additional increase to 5% employee contribution and 3% employer contribution from 6 April 2019 onwards.
Schemes such as the Save More Tomorrow initiative are now seeing greater popularity. This approach was developed in America by Richard Thaler, professor of behavioural science at the University of Chicago’s Booth School of Business, and Shlomo Benartzi, a professor at the University of California Los Angeles' School of Management. This initiative sees staff commit in advance to allocating a portion of their future pay rises toward retirement savings.
With more employees than ever reportedly on course not to achieve their desired income in retirement, setting an appropriate contribution structure to kickstart and encourage good savings habits is vital. In doing so, employers will also recognise key business benefits, particularly around staff attraction, retention and engagement.
Nationwide Building Society introduces higher minimum pension contribution level to improve retirement outcomes for staff
Nationwide Building Society updated its defined contribution (DC) group personal pension (GPP) plan to default 12,000 scheme members on to a higher contribution rate, to ensure staff access the maximum employer contribution and to help improve retirement outcomes.
Following a benchmarking exercise in 2014, Nationwide found that the majority of its DC members had opted to pay the minimum contribution of 4%, which attracted a 9% employer contribution for staff with more than two years' service and 5% for those who had been with the business for less than two years. Just 9% of members had chosen to increase their personal contribution above this level.
To improve employees’ retirement savings and ensure all members took advantage of the maximum employer contribution available, aligning with the organisation’s core principle of ‘doing the right thing’, Nationwide decided to re-design its core contribution level to which employees are defaulted. As a result, it increased this to 7% employee contribution. It also took the decision to increase the level of life assurance from four-times salary to eight-times salary.
The changes were introduced gradually, beginning with a communications campaign in March and April 2015 to raise awareness around pensions and savings generally. It then officially communicated the scheme changes between July and September 2015. Communications included an animated film, manager and team briefings that included news stories, poster competitions, face-to-face presentations and roadshows.
The higher default level was implemented in January 2016, with a new core employer contribution rate of 13% subsequently introduced in September last year. If employees wanted to opt down and return to paying a lower contribution rate, they have the opportunity to do so during the organisation's flexible benefits election window between October and November. Every year, the contribution level re-sets to the core default contribution level, meaning employees have to make an active decision about their pension contribution level on an annual basis.
In January 2017, 84% of DC scheme members had remained at the higher contribution level.
In May, Nationwide will introduce Hymans Robertson’s Guided Outcomes retirement planning tool to further aid staff in preparing for their retirement. The tool will enable employees to set their retirement savings target and check whether they are on track to achieve this, as well as give suggestions on how to improve the likelihood of reaching their pensions savings goals.
Ian Baines, head of pensions at Nationwide, says: “We felt if our employees were not likely to be on track for a good pension outcome at retirement, that wasn’t a good thing for us as a responsible, good employer. We felt the right thing to do was to pay [a higher] contribution into their pension so they had that good outcome.”
Viewpoint: Higher contribution rates will bring savers closer to retirement targets
With the 2017 review of automatic-enrolment approaching, the Pensions and Lifetime Savings Association (PLSA) spent 2016 researching adequacy in pension saving. Together with Hymans Robertson, we used data on pension wealth and other savings to build a picture of what retirement incomes could be for the population of Britain, assuming that automatic-enrolment proceeds as planned. To get an idea of how the future could be different, we also modelled higher contribution rates and later retirement dates.
What we found has real implications for those designing in-house defined contribution (DC) scheme contribution structures. Our initial assumption was that a wide range of demographic factors would drive retirement saving adequacy. In fact, age emerged as the critical demographic factor with others much less important.
Our modelling showed that the millennial generation would be likely to get to a good replacement rate with a 12% DC contribution rate, assuming that they are willing to work longer. We assumed that to be five years beyond state pension age. We also found that about half of the generation closest to retirement were likely to achieve an adequate retirement income mainly due to the presence of defined benefit (DB) arrangements among that population than any difference made by DC saving.
For the middle generation, where defined benefit (DB) entitlement is less common and where DC histories are less developed, the future looks tougher. Contribution structure design will need to take account of a cohort aged between their mid 30s and mid 50s, for whom retirement saving is frequently not on track. While it is going to be hard to alter this trajectory, any additional saving is very likely to be good saving for this cohort. They may not be likely to achieve a replacement rate of two-thirds of median income but higher contribution rates may bring this generation closer to that target.
Tim Gosling is policy lead: DC, at the Pensions and Lifetime Savings Association (PLSA)
