To save or not to save, that is the pension

16th June, 2012

‘The government’s pension reform is the most radical change in decades. But according to the OECD, the reform is unlikely to achieve its goals because saving will not be compulsory.’

Financial Times, June 12

Sorry, I didn’t pay any attention to that. I’m browsing reviews for the new Samsung phone.

Well, you’re exactly the problem, then: too busy thinking about consumption today to save for your pension.

Well, my father always says “you can’t take it with you”.

I see. And what happened to him?

He survived a heart attack, took early retirement and at 78 he’s into his third decade of a civil service pension. “Every day’s a holiday”: that’s another of his mottos.

I can see why.

Mind you, I have four siblings so I don’t know if my mother saw it that way.

Your father is a wonderful example of why things have to change and why we don’t want them to. First, he’s already lived longer than expected. Second, he has had a long retirement after a short career. Third, he has lots of children. As long as each generation is much larger than the previous one, it can easily afford to pay for retirement luxuries for the elderly. But fertility has fallen and longevity is rising – your life expectancy is increasing by about five or six hours a day. So it seems difficult to provide for future generations the sort of effortless pension that your father receives.

My heart bleeds.

As well it might because your generation are likely to get pension reform good and hard. The state pension in the UK is universal but minimal, although the government plans to beef it up while gradually deferring it. Alternative pension provision is thus essential.

Wake me up when the sermon is over, OK?

Fine. While you’ve been sleeping, companies have closed their “defined benefit” schemes. These used to provide the kind of absolute certainty that your father received. The replacement, “defined contribution” schemes, are not only less certain but are also less generous. Worse, many employees don’t sign up for such schemes at all.

And what’s that got to do with Fifa, or whoever has been grumbling about our pensions?

It’s the Organisation for Economic Cooperation and Development. They have been commenting on the government’s new wheeze – which has been in the pipeline for several years – to set up a low-cost private-sector scheme with contributions from employer, employee and government, and in to which every employee is automatically enrolled, or into an acceptable alternative.

Sounds pretty compulsory to me.

Auto-enrolment isn’t compulsion, it’s behavioural economics. It turns out that default options can influence behaviour greatly. The government has taken the view that most people would want a subsidised pension if only they thought rationally about it. Auto-enrolment is supposed to give people what they probably need, while giving them the freedom to opt out if they want.

Who would want that?

If you were trying to save a deposit for a house, or some other one-off expense such as a wedding, you might be better off stopping pension contributions for a bit, rather than take on expensive debt. And there’s another problem: many low-income pensioners receive means-tested supplements to their pension. If you expect to fall into that category then contributing to your pension simply eats away at your future means-tested benefits. For all these reasons, plus the increasingly old-fashioned values of liberty and autonomy, the government wants to let people refuse to save for a pension if they choose to.

So what is the OECD worrying about?

If your only aim is to maximise pensions then of course you must make it compulsory and the OECD’s report was about pensions. But if you have practical or philosophical reasons to respect people’s right to opt out, then auto-enrolment is probably your best bet.

But there will be a shortfall.

Yes, there will. Richard Thaler, the Chicago economist who is arguably the godfather of auto-enrolment, reckons that enrolment rates in comparable schemes in the US are 90 per cent. In New Zealand they are close to 70 per cent. That’s not ideal. But neither is heavy-handed compulsion. And after all, you have a phone to buy.

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