The think tank said the reforms are needed as millions of employees are currently on track for inadequate retirement incomes.
The IFS also said there was a ‘strong case’ for employees to receive an employer pension contribution of at least 3% of total pay, irrespective of whether they contribute themselves.
Another suggestion is that increased default employee contributions should be targeted at people on average incomes and above.
The current automatic enrolment default minimum contributions are 8% of earnings between £6,240 and £50,270 (employer contributions making up at least three of the eight percentage points). But the IFS said that increasing contributions for those with low current earnings risks reducing take-home pay at a time in life when this can least be afforded.
However, increasing the default minimum on the portion of earnings above a certain threshold would help some middle and higher earners better supplement their state pension.
For example, it suggested there could be a 12% default total contribution rate for the portion of earnings above £35,000 (around median full-time earnings), with the additional contributions coming from employee contributions.
‘Pension participation up, but challenges remain’
The report, undertaken as part of the Pensions Review in partnership with the abrdn Financial Fairness Trust, found that auto-enrolment has dramatically increased private sector employees’ participation in pension saving, but several challenges remain.
The IFS found that most people make low contributions – less than half of private sector employees who save into a workplace pension contribute more than 8% of their earnings. A fifth still do not save in a workplace pension so they miss out on their employer’s pension contribution.
The report found that approximately 30% to 40% of private sector employees saving in defined contribution pension schemes are on course to have individual incomes that fall short of standard benchmarks in retirement. However, it noted that ‘prospects look better accounting for partners’ pensions and potential future inheritances’.
The IFS reported suggested that a set of changes to the automatic enrolment system are needed. Rather than increasing minimum pension contributions for all, it has suggested a more targeted approach that helps employees to save more at points in their lives when they might be more able to do so.
The report said there is a good case for the upper limit on qualifying earnings – which has been frozen at £50,270 since 2021/22 – to be raised, at least for minimum employee contributions.
The IFS also said there is a clear need to future-proof the system, by indexing key parameters in the auto-enrolment system to average earnings growth. The ‘earnings trigger’ (above which people have to be automatically enrolled) is now 13% below the annual value of a full new state pension (£11,502), whereas on its introduction in 2012, it was 45% higher than the then annual value of a full basic state pension.
The think tank calculated that, overall, implementing its suggestions would boost retirement incomes by between 12% and 16% (£1,400 to £2,100 per year) for those currently on track for low and middle incomes in retirement.
Supplementing the state pension
Laurence O’Brien, a research economist at IFS and an author of the report, said: “While the state pension now provides a strong foundation income in retirement, most will want or need to supplement that.
“Too many private sector employees appear on course to end up on a low – or disappointing – retirement income. While there is often concern about savers not saving enough, an additional problem is that despite automatic enrolment boosting workplace pension membership, more than one in five private sector employees are still not saving in a pension.”
Mubin Haq, chief executive of the abrdn Financial Fairness Trust, said: “Auto-enrolment has been a huge success, significantly increasing the numbers saving into a pension. However, there’s much more it could achieve, especially for low earners who are currently missing out from an employer paying into their pension pot.
“Guaranteeing 3% from the employer regardless of whether an employee makes a contribution could boost employer pension contributions by £4bn per year. This would particularly benefit women, those working part-time, young adults and the low-paid.”
