‘Doubling contributions is the first step to solving the pensions crisis – and rebooting the City’

In the debate about how to revitalise the UK’s capital markets, the nation’s pensions savings are often seen as part of the solution. What tends to get overlooked, however, is that pension money belongs to real people – and needs to achieve a decent return. And, as a nation, we are still not saving anywhere near enough to fund retirement.

There is a very real crisis brewing for millions of individuals in the coming decades in terms of an inadequate income in retirement. Defined contribution pensions will not provide the safety net implied by the word “pension”. Certainly not with only 8% of salaries being paid into those schemes annually, as they are at present. This needs to change.

To have any chance of achieving decent retirement outcomes, the contribution rate needs to double – taking it closer to the levels seen in other developed economies.

Getting more money diverted to pensions savings needs to be our first priority. Once we have broad political consensus on that point, we can then spend more time thinking about what those schemes invest in, the returns they achieve – and what can be done in turn to ensure that those savings contribute to more vibrant capital markets in the UK.

These two problems are unquestionably related and intertwined. Yet they are two problems, not one.

A new report to be published tomorrow by the think tank New Financial in partnership with abrdn and Citi asks that we all reframe the exam question on these two “parallel crises”.? If we think less about ways to mandate pensions schemes to invest in UK assets, and more about how we get them to work better for savers, then we might potentially arrive at a similar place.

But the debate around any future reforms needs to begin and end with what’s best for savers. Any upside for capital markets then becomes a secondary but important benefit, rather than an object of policy.

There is roughly ￡3 trillion in UK pensions, held by roughly 25m people. The average return on UK pension assets between 2010 and 2020 was 6.2%. That compares favourably to the US, at 4.9%. But the returns lag other countries with big, sophisticated pensions savings systems such as the Netherlands at 7.6%, and Australia at 7.5%.

On some estimates, those lost returns mean that a typical UK saver setting aside cash every month for 30 years would end up with a pension pot 30% smaller than the average Australian saving the same amount. That’s a big gap.

Those markets with better investment returns have higher allocations to equities and to alternative assets. That’s where the parallel crises come together: greater diversification should, over time, lead to better returns.

The funds that provide access to these asset classes come with higher management charges. Those charges are viewed simply as costs by most pension trustees. Yet the focus on annual management charges overlooks the cost of lost investment returns.

The Mansion House reforms announced by the Chancellor in the summer proposed multiple ideas to incentivise changed behaviours among those running defined benefit pensions schemes or pots of insurance money. This was a good start.

The New Financial report sets out a number of ways in which the reforms could go much further. We remain to be convinced on some of the proposals made, but if we want to address seemingly intractable problems, we will need to challenge ourselves. Otherwise, nothing will change.

This is a time when we need visionary thinking and boldness from our policymakers which transcends political boundaries, as happened with the advent of automatic enrolment into workplace pensions. Tinkering around the edges is unlikely to cut it.