Tackling DC pension inequality through contribution design
07 Feb 2024
In an era marked by bold commitments to Diversity, Equity & Inclusion (DE&I) by employers, financial wellbeing strategies, government announcements and regulatory pension consultations, the conversations on Defined Contribution (DC) pension inequality have been brought to the forefront. And one area that is slowly surfacing is the role of DC contribution design, a topic that a number of organisations are now reassessing.
The new area of focus
The emphasis is on the popular matching contribution ladder structures in DC pensions. This financial incentive was introduced to encourage employees to save more for their retirement, and in return the employer would contribute proportionately more too. This concept, originally inspired by similar practices in the USA, has become the most common form of pension contribution design. However, the reality is that this incentive has become deeply constrained for many members. Our Guided Outcomes® analysis has revealed that the benefits of this structure have been disproportionately skewed towards wealthier and older members, especially in light of the current cost-of-living crisis.
As a result, the incentive is distorting savings between those who can and those who can't. Many employees simply can't afford to contribute extra to get extra. Simply put, in today's DE&I language, it’s 'inequitable'. For example, there are UK employees working side by side doing the same job, but due to their personal financial circumstances, are getting paid differently. In more traditional language, matching contribution ladder structures may be curbing 'upward social mobility'. The collective idea for the UK is that hard work by anyone should bring with it the means to progress to a better financial future.
To preserve or not?
The merit of incentivising employees to save for their future still remains with this matching ladder structure. On one hand, we can quantify the exact extra rewards for the wise saver, and we can remind employees that it offers 'free money'. But, on the other hand, formal DE&I policies at FTSE companies emphasise eliminating unintended barriers and embedding equality in all practices. This raises important questions about the fairness of the system. For example, how do we view those returning from parental leave and trying to get back on a financial even-keel - should they forfeit maximum employer contributions in the meantime? Or younger employees burdened with student debt and saving towards property deposits - is it ok that they’re instead obliged (possibly not in their best interest) to pay-in their spare income to access maximum employer contributions?
There’s also greater appreciation that disabled employees have demonstrably higher living costs than average and have to dig deeper than others to enjoy maximum employer contributions. Some may not be able to for this reason.
Finally, we know some employees come from socioeconomic backgrounds where their communities' longevity expectations and long-term savings perceptions mean they’re simply more disengaged – it seems inequitable that they should still receive less.
Exploring new pension benefit approaches
Many organisations are now looking for ways to support employees with these kinds of challenges - and a new pension benefit approach may be the way to do this. Alternative contribution design approaches do exist. We’re seeing organisations explore approaches that align with current supportive measures, like pension holidays and cost-of-living payments. We’re working with clients to explore and implement these options. For example, defaulting employees annually to adequate employee contributions has shown success in maintaining positive savings levels without the need to link them to employer contributions. There are also other structures that can work well in specific industry sectors.
The potential impact of change
A change could have a huge impact. For those employees affected by this issue, our Guided Outcomes® analysis suggests improvements to retirement outcomes in a typical UK scheme of up to 28%. Scheme objectives on pension savings gaps could also be enhanced. Such a change could not only address the pension savings gaps but also contribute to upward social mobility, improved longevity, and health spans, and ongoing positive intergenerational effects.
At Hymans Robertson LLP, we see opportunities for change and are working with clients to explore and implement innovative and equitable arrangements. In a world where the social narrative is dominated by cost-of-living increases, there’s a real opportunity for a positive change that materially benefits employees – without necessarily imposing unaffordable expense on employers.
If you'd like help revisiting your contribution design or simply would like to discuss these ideas more generally then please do get in touch.