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We’ve partnered with Oxford Economics to analyse the effect that increasing UK pension contributions could have on pension adequacy and economic growth.
Although Automatic Enrolment (AE) has increased pension participation, many UK employees are still not saving enough for retirement. This latest research indicates only 36% of people with a defined contribution (DC) pension are projected to meet Target Replacement Rates (TRR) - the percentage of pre-retirement earnings a person would need to replace to meet an adequate income in retirement - by 2040. Falling to 26 percent under the Retirement Living Standards (RLS) benchmark.
Understanding the impact of higher pension contributions
We’ve looked into how increasing pension contributions could impact employers, employees, and the UK economy. This summary is designed to help UK employers understand the strategic and operational impact of upcoming pension changes and prepare their workforce for the future.
Why do we need to review workplace pension contributions?
Although AE has significantly improved pension participation, research shows that many UK workers are still at risk of insufficient pension savings. By 2040, only 36% of defined contribution (DC) households are expected to achieve the recommended TRR, which is essential for maintaining their lifestyle in retirement. Just 26% are expected to reach the moderate RLS threshold. To address this gap, policymakers are considering further reforms, which could mean higher legal minimum pension contributions and changes to auto-enrolment rules. These potential changes could have both direct and indirect effects on employers.
The research approach: Data-driven scenario modelling
Oxford Economics assessed the impact of five potential policy scenarios, each exploring different ways to increase pension contributions and adjust enrolment thresholds. These scenarios included:
- lowering the age of auto-enrolment to 18
- removing the lower earnings threshold
- raising combined employer and employee contribution rates to between 10% and 14%
- linking rates to income bands and target adequacy.
The impact of these scenarios was then evaluated at both household and macroeconomic levels.
1. Financial impact on employers
Across all scenarios, employers are expected to take on a larger share of increased pension costs, particularly in income-linked and universal contribution rate models. Many large employers may already be contributing above the minimum levels. Increasing contributions may be more difficult for smaller employers, and this needs to be part of the debate.
Our research found that an income-linked increase in contributions spreads costs more evenly, reducing the burden on employees with lower-incomes and their employers.
2. Workforce affordability and short-term resilience
Higher pension contributions reduce take-home pay, which may affect employees’ short-term financial resilience. The impact is most significant for employees on lower-incomes if a universal rate is applied.
Including younger employees in auto enrolment and increasing their contributions can significantly increase their future pension adequacy. However, this may require additional employer support and clear communication.
3. Closing the pension adequacy gap
The percentage of households achieving adequate retirement income increases with each scenario, with the largest gains from a 14% universal contribution rate. However, targeted increases linked to income provide similar improvements in adequacy while placing less strain on disposable income.
Even with reforms, many employees, especially younger and lower-income groups, will need additional support to reach retirement adequacy.
4. Macroeconomic and business investment effects
In the short term, higher pension costs could lead to lower disposable income and slower wage growth. Employees’ disposable income is projected to fall by 0.1% to 0.6% in the short term, depending on the reform scenario. However, increased pension savings are expected to boost long-term investment in UK productive assets, which could support stronger GDP growth. By 2060, UK GDP could be £0.7–6.2bn higher than baseline forecasts, depending on the scenario. While government revenues may initially dip due to lower wages and profits, improved economic growth and higher pensioner incomes are expected to close this gap over time.
5. Policy context: Mansion House Accord
The Mansion House Accord commits defined contribution pension providers to invest more in UK private markets. This shift in asset allocation is expected to boost the economic and business benefits of higher pension contributions.
Conclusion
The research supports a phased, long-term plan to gradually increase minimum contribution levels - a necessary step if we are to address the UK’s pension adequacy gap. The long-term advantages should be a win-win for employers and employees alike.
While employers may face higher short-term costs, the long-term benefits include a more financially secure workforce, potential improvements in business investment, and a stronger economic outlook. Although this may not be the right time to make that leap, by planning ahead and engaging your employees, you can help close the pension adequacy gap while strengthening your business for the future.
Practical steps for employers
Any increase to AE minimum contribution rates isn’t going to be immediate, and they’re likely to spread over many years. We recommend:
- Planning for higher pension costs in your future workforce budgets. This could help you feel better prepared if reforms do require increased employer contributions.
- Get employees who are younger or on lower incomes involved early to help them build a more secure financial future while supporting their short-term financial wellbeing.
- Communicate the value of pension saving and the long-term benefits of increased contributions to help employees understand and adapt to changes in take-home pay.
- Monitor policy developments around enrolment, minimum contributions, and UK investment initiatives to stay compliant and competitive.