Last week saw global share prices fall by more than 5%. This was the largest weekly decline for two years as an unusually long period of calm came to a violent end amid concerns over rising US interest rates. News bulletins, somewhat predictably, featured worried-looking City workers on the phone. But away from bank trading floors, do such price changes matter to the average Briton? The answer is yes. And more importantly, they matter more now than at any time in the recent past.
The reason for this increased relevance is recent government reforms to workplace pensions. I tend to find that the mere mention of pensions triggers an awkward silence. If you want space at the bar, start talking loudly about pensions. However, it is no exaggeration to say that the UK is in the middle of a quiet revolution in workplace saving. By the end of 2018 there are expected to be 10 million more people contributing to a workplace pension than in 2012. One in three UK workers has been impacted.
That a change on this scale has been possible is a triumph of 'Nudging'. Nudges are often used where governments take a view on the best outcome, then design public policy to encourage citizens towards a particular outcome. In the case of workplace pensions, employees have been automatically enrolled, or “nudged”, into employer-sponsored savings schemes. This comes as the government tries to tackle the 12 million Britons deemed to be undersaving for their retirement.
Surveys have indicated that few workers have actually noticed much of a difference. Indeed the average contribution by newly-enrolled employees has been just £6 a week. This low starting level of saving – the legal minimum - has been designed to deter UK workers on relatively modest incomes from withdrawing from workplace pensions. This has proved successful as opt-outs have been less than 10%.
The result is that after years of declining pension scheme membership, more UK workers are now directly invested in the stock market than ever before, with a significant proportion of contributions used to purchase shares. The value of these contributions will be determined, in large part, by the performance of global stock markets over the coming years. What happens in stock markets now will impact retirees for decades to come.
However, two new challenges now loom. Firstly, starting in April, those minimum contributions are set to increase sharply. Over the next two tax years, millions of low-to-middle income savers will be asked to contribute an average of £30 per week – a five-fold increase on current levels. The danger is that these contributions start to become an amount that workers miss from their take home pay. This impact will be further accentuated if the backdrop to these increased contributions is a volatile stock market. The government is rightly concerned that this will increase opt-outs and derail recent progress.
The second challenge is current levels of wage growth. When this policy was first envisaged, way back in 2004, it was assumed that wages would be increasing at nearly 5% a year. Increasing pension contributions would therefore be simply “lost” within annual pay increases. The reality is that wages are rising by just 2.5%. This makes it harder for savers to stomach pay packet withdrawals, even for good long-term reasons, when bills need to be paid.
So, while we must celebrate the phoenix-like recovery in UK pension saving – set to hit £100bn a year by 2020 - this is the start, not the end, of the story. In particular, financial literacy amongst savers is an essential accompaniment to rising pension membership. The temptation to opt-out of pension saving grows for even the most experienced of savers when stock markets are falling. For many Britons, with vastly less experience, a comfortable retirement hinges on smart decisions over the coming months.
This article was published in The Times newspaper.