Pension regimes struggle to gain trust of workers, says OECD

People remain slow to trust pension promises, a new OECD report has found.

Low investment returns on pension savings, less stable employment structures, low economic growth and the fact that people are living longer have all eroded belief that pensions "will deliver on their promises once workers reach retirement age", the OECD Pensions Outlook 2018 reports.

Poor pension coverage among some workers has also contributed to this scepticism.

“People are also concerned about whether the institutions managing their retirement savings in funded pensions arrangements have their best interests at heart,” the report accepts, despite a string of pension reforms across different countries in recent years.

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The report says people need to increase retirement savings – both in the amount they contribute and starting those contributions earlier in their working lives.

“This is even more necessary as improvements in mortality and life expectancy lead to ever-longer periods in retirement,” the report warns.

It adds that pension reforms must be better communicated so that their rationale and effects are clearer.

And it acknowledges that people in defined-contribution schemes – where the pension pot is determined by how much you put in and the investment return on those funds – bear the greatest risks in pension saving to ensure that their pension is sufficient to last their full lifetime. This contrasts with the security of defined-benefit pension schemes where a proportion of final salary is promised as income in retirement.

Contribution vs benefit

In Ireland, increasingly, defined-benefit schemes are available to people in the public sector. Most private sector workers have access only to the higher-risk defined-contribution schemes.

The report also looks at mandatory pension provision – along the lines of the auto-enrolment regime planned for workers in Ireland from 2022.

It says that, short of compulsory pension arrangements where no opt-out is available, auto-enrolment is the best way to ensure higher private pension provision. The Pensions Outlook studies the eight existing auto-enrolment regimes in OECD countries.

In the UK, which introduced auto-enrolment in 2012, the report cites research showing it has increased occupational pension membership by 37 percentage points. The UK also features re-enrolment every three years of those who have opted out in order to further encourage retirement saving.

The report – the fourth produced by the OECD over a number of years – is designed to help governments design pension policy by drawing together the experience across member states.

It supports the idea of defaults in an auto-enrolment strategy for contributions, the pension provider, the investment strategy and the post-retirement option to simplify decision-making for those unwilling or unable to make those choices themselves. However, it warns they need to be well-designed to ensure they do not lock people into “sub-optimal arrangements” and there does need to be a degree of choice for those prepared to make their own decisions.

One of the issues with auto-enrolment is that, to avoid opt-outs, contribution levels are set too low to have a realistic chance of providing adequate retirement income.

The OECD calculates that people need to be saving just under 13 per cent of their gross salary annually over 40 years to have a 95 per cent chance of securing a retirement income of about 30 per cent of what you earned in employment.

Tax relief

Tax relief on pension contributions and returns – with tax paid when the money is drawn down in retirement is seen as the most advantageous to savers. However, lower-income groups, that may not benefit as much from tax relief, can respond better to upfront cash in matching contributions from employers and government.

The report also examines arrangements such as Ireland’s approved retirement funds (ARFs) which are taxed on the presumption that people will withdraw 4 per cent of their funds annually after retirement up to the age of 71 and 5 per cent per annum thereafter.

It describes this approach as the “farthest from the optimal” in ensuring people do not run out of funds in the older years as longevity rises, and recommends instead a regime that would divide assets in line with expected life expectancy as predicted by actuaries at the time of retirement.

On survivor’s pensions, where a spouse or partner continues to receive a pension income after the pension scheme member dies, the report says this should not be a permanent entitlement if the spouse or partner is not yet of retirement age.

“Instead, temporary benefits should be available to help adapt to the new situation,” it advises.

It also says that, for reasons of fairness, a single pensioner with no dependent should receive a higher monthly payment than a member with a spouse or partner who would be in line for a survivor’s pension.