They see me automatically enrolling. They saving?

Retirement might seem an awful long way off when you are studying for your A-Levels, but time catches up with everyone eventually. An average person in the UK can expect to spend almost one third of their adult life above the state pension age, which explains why saving for retirement is such a large industry. But are people saving enough for retirement? And, what can pension saving teach us about how people make economic decisions?

The state pension will only go so far

The UK government does provide some support to pensioners, predominantly in the form of the state pension. This is worth approximately £9,600 per year for those reaching their state pension age today with a full entitlement, which is the vast majority of people who have lived and worked in the UK their whole working life. 

However, £9,600 won’t cut it for many people. Indeed, most people get accustomed to a much higher level of income than that during working life, and might struggle to adjust to suddenly receiving a much lower income when they retire. For example, median weekly pay for full-time employees is slightly over £33,000 per year in 2022, over three times the annual value of the state pension. In addition, the state pension age, the earliest age at which people can claim their state pension, is currently 66 and rising. Anyone wishing to stop working earlier than their state pension age might want another source of income to tide them over until their state pension age. 

For these reasons, private pension saving is particularly important in the UK to ensure a reasonable standard of living in retirement. But, there are concerns that many people are not saving enough into their pension: for example, in 2020, only 57% of people between the ages of 16 and state pension age were contributing to a private pension. 

Jam today, no jam tomorrow

Undersaving for retirement creates a bit of a quandary for traditional economic theories. Generally, these theories assume that people are rational decision-makers, who can accurately assess the benefits of different options and choose the one that maximises their wellbeing. Undersaving for retirement cannot easily be explained by these theories, as it suggests that people are making a systematic misjudgement.

Of course, we all know that no one behaves as perfectly as suggested by traditional economic theories. When it comes to saving for retirement, a particular problem is “myopia”, or short-sighted decision making. People may accept that it is important to save for retirement, but put off saving for a future date. When that future date comes, though, they are still reluctant to increase their pension saving and kick the can down the road yet again.

Automatic enrolment to the rescue

In response to fears that many people in the UK were undersaving for retirement, the UK government set up the Pensions Commission in the early 2000s, leading to the Turner Report. One of the key recommendations of this Report was the policy of automatic enrolment, which was rolled out between 2012 and 2018.
Automatic enrolment obligates employers to automatically enrol their employees into a workplace pension, conditional on the employee being between age 22 and state pension age and earning over £10,000 per year. Therefore, the decision of joining a pension for employees went from an opt-in choice, where the default option was not to save in a pension, to an opt-out choice, where the default is to save. 

Traditional economic models would predict that automatic enrolment would have no effect on pension saving behaviour. The default choice does not matter: rational people would still save the amount into their pension that would maximise their lifetime wellbeing. But automatic enrolment did have an effect on pension saving, and a large one too. The proportion of private sector employees who were saving in a workplace pension increased from 32% in 2012 to 75% in 2021. 

This suggests that traditional economic theories are missing something else important about how we make decisions. In particular, we often evaluate different options relative to a reference point and exhibit loss aversion relative to this point. Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains, and this means that changes in the reference point can lead to changes in decisions. When it comes to pension saving, changing to an opt-out system led people to stop seeing saving in their pension saving as a loss in income today, leading to higher rates of pension saving. 

Inertia – the tendency to stick with the status quo – is a related behavioural bias that can also explain the success of automatic enrolment. Deciding to make a change is hard: for example, you might try to convince yourself that you will start to actually make use of that gym membership in the new year, or you might want to avoid the hassle of ringing up to cancel it. There are also costs to deciding to change your pension contributions, both costs in terms of time but also cognitive costs, since trying to work out the “optimal” contribution rate is a very complicated decision. So, rather than spending time thinking about this, people may be likely to stick with the status quo. Automatic enrolment, by changing the status quo from not saving in a pension to saving in a pension, takes advantage of this inertia to increase levels of pension saving. 

Automatic enrolment therefore demonstrates how incorporating insights about how people make decisions from the fields of behavioural science and psychology can lead to successful policies.

But is automatic enrolment enough?

The policy success of automatic enrolment has not, however, completely quelled the concerns about undersaving for retirement in the UK. 

First, there are concerns about undersaving among the self-employed: only 20% of self-employed workers were saving in a pension in 2020. The self-employed, by definition, do not have an employer who can automatically enrol them in a pension, and so were not affected by automatic enrolment. There is currently an active policy debate about how to increase pension saving among these workers.

But there are also concerns that even many employees are not saving enough for retirement. While automatic enrolment led to a large increase in the share of employees who were saving in a workplace pension, the amount they are saving also matters. Under automatic enrolment, employers have to default workers into saving at least 8% of pay into their pension (with at least 3% coming from the employer). This is now the most common pension saving rate, but saving 8% of earnings into a pension over a whole career might not be enough to ensure an appropriate standard of living in retirement for everyone. There are therefore discussions about whether the minimum default contribution rate should be increased above 8%, and, if so, for whom.

More reforms aimed at boosting pension saving are therefore expected to be discussed and legislated over the next decade. These policies, as well as hopefully improving people’s retirement outcomes, may offer further insights about how people make decisions in the real world, and how these decisions deviate from the predictions of traditional economic theory.