Millions of UK Workers Face Lower Retirement Incomes Without Urgent Pension Reforms

A new study from the Pensions Review, conducted by the Institute for Fiscal Studies in collaboration with the abrdn Financial Fairness Trust, has revealed that between 30% and 40% of private sector employees in the UK are at risk of falling short of income benchmarks for a comfortable retirement. The research highlights that approximately 5 to 7 million workers in defined contribution pension schemes may face inadequate retirement incomes. While this outlook improves slightly when factors like partners’ pensions and future inheritances are considered, the scale of the problem remains considerable.

The report emphasizes that the current system requires urgent reforms to prevent widespread pension shortfalls. One suggested approach is to raise minimum pension contributions to 12% of earnings, which could substantially enhance retirement incomes. However, the report advocates for a more nuanced approach, targeting those able to contribute more at specific points in their lives. This would boost pension savings while mitigating the potential affordability concerns for lower earners.

One of the key proposals is to ensure that employees receive an employer pension contribution of at least 3% of their total pay, regardless of whether they contribute themselves. This change would be particularly beneficial for the 22% of private sector employees who either opt out of their pension scheme or are not automatically enrolled due to low earnings. Such a measure would help ensure that these employees continue to save for their retirement, while minimizing the risk of wage suppression, a potential downside of increased employer contributions. Although there is concern that more employees may opt out of contributing themselves, the researchers believe this number would be minimal. To alleviate concerns, a government trial of this approach could be considered before full implementation.

Another recommendation is to expand the age range for automatic enrolment into workplace pensions. Currently, only those aged 22 and over are automatically enrolled. The report suggests lowering the starting age to 16 and extending the upper limit to 74. This expansion would capture a larger portion of the workforce and encourage early saving habits, setting individuals on a stronger path toward a secure retirement.

Additionally, the report proposes increasing default employee contributions, specifically targeting those on middle and higher incomes. The current automatic enrolment scheme sets minimum contributions at 8% of earnings between £6,240 and £50,270. However, increasing contributions for low earners could reduce their take-home pay at a time when they may be least able to afford it. Instead, the report suggests raising the default total contribution rate to 12% for earnings above £35,000, with the additional contributions coming from the employee. This approach would help higher earners save more, while allowing those with fluctuating incomes to build a larger pension pot in years of higher earnings.

The upper limit on qualifying earnings, currently frozen at £50,270 since 2021–22, also warrants revision. The real value of this threshold has eroded in recent years, making it harder for some employees to make sound long-term saving decisions. Increasing this limit, at least for minimum employee contributions, would allow more individuals to boost their savings. Additionally, the system should be future proofed by indexing key parameters, such as the earnings trigger for automatic enrolment, to average earnings growth. Since its introduction in 2012, the earnings trigger has fallen in real terms, and is now 13% below the annual value of a full new state pension (£11,502) or £221.20 per week, compared to being 45% higher than the full basic state pension in 2012.

The report also outlines measures to address concerns about affordability, especially for lower earners. One such measure is giving employees the option to “opt down” to the current minimum pension contribution rates if higher default contributions prove unaffordable. This flexibility could alleviate financial pressure while still encouraging higher savings rates for those who can afford it. Furthermore, if the government moves forward with legislation passed in 2023 to increase default contributions by basing them on earnings from the first pound, consideration should be given to diverting the additional contributions into a liquid savings account. A model similar to the NEST sidecar account would allow individuals with limited liquid assets to build up “rainy day” savings, which could be more appropriate for their immediate financial needs than long-term pension savings.

The suggested reforms could lead to an increase in retirement incomes by 12% to 16%, equating to an additional £1,400 to £2,100 per year for those currently on track for lower or middle incomes in retirement. Crucially, these changes would only result in a minor reduction in take-home pay for lower earners—likely less than a 1% decrease. This relatively modest impact on take-home pay can be attributed to the fact that some individuals who are on track for low retirement incomes may have higher earnings at certain points in their careers, allowing them to save more during those periods. In contrast, a blanket move to a 12% minimum contribution rate would boost retirement incomes but at the cost of significantly reducing take-home pay for lower-paid workers.

These findings and policy suggestions offer a roadmap for addressing the pension shortfall faced by millions of UK employees. With a more targeted approach that balances increased pension savings with the affordability concerns of lower earners, it is possible to improve the outlook for a secure retirement without imposing undue financial strain on those who need to prioritize current income over future savings. Implementing these recommendations would help future-proof the UK’s pension system, ensuring that more people are able to enjoy a comfortable retirement.