When Ten is a “10”: Auto-enrollment in the UK paves the way

We’re excited to talk with our friend Will Sandbrook for several reasons. One, he’s been with Nest Corporation (UK) since it started. Ten years on, we want to know what he sees. Two, Will is Managing Director of Nest Insight, Nest’s in-house research and thought leadership unit focused on delivering cutting-edge research into how to improve retirement outcomes for the ‘DC generation.’

We always want to know what’s fresh news where he is. Among other initiatives, we touch on new results from the emergency savings space. Almost everything that’s going on in the UK is, or will soon be, very relevant to us in the US. You can see more of Will’s impressive credentials below.

Will Sandbrook – we are now at the Nest ten-year mark. That was fast. What’s been the impact of Nest and its related legislation in the UK?

You’re right – the impact here is both the ten-year anniversary of Nest, and the ten-year anniversary of the auto enrollment mandate in the UK.

More savers. Between those two interventions, the UK's gone from hovering at under half of workers saving for their retirement to something like 80% of workers saving for their retirements. That's a pretty massive behavioral shift.

The role that Nest has played, in particular, has been about bringing broad access to the type of high quality, large scale institutional structures at low cost that, prior to Nest, would have been the preserve of people working for large well-funded employers with large well-funded employer plans.

Extended market reach. Now with Nest we have a low- and moderate-income mass market concept that makes auto enrollment work right down to the smallest employers, the lowest income workers, and the people who are shifting in and out of multiple jobs through the year.

Nest has really been the supply-side piece that has made the demand-side intervention of auto enrollment work for everybody. It’s turned pensions from an upper-middle-income and higher-income concept to one that's really very widely democratic and mass market now. That's been a really big step change for us. (Much more about Nest here).

To use a fun phrase, you’ve now got "universal workplace savings" in the UK.

Absolutely. I’d say universally available and almost universally participated in. That's the step change we've been through in the UK in the last ten years: something like 10 or 11 million more people saving for their retirement than there were before.

We're just getting started with universal workplace savings here in the US. Awareness is on the rise but still moderate. With your longer tenure, what's been your experience?

Yes. To an extent, that's probably true in the UK as well. The thing with the wide scale use of automatic enrollment is that it works differently for different people. There are some people who have always known they should be doing something for their retirement and were aware of workplace pension saving, but for all the well-known behavioral obstacles never quite got around to signing up.

I meant to do it. With those people, you tend to see a pretty good level of awareness and a lot of relief when they get automatically enrolled. We've been doing some customer closeness work. I was on a zoom call with one of our members a couple of weeks ago. She was absolutely in that camp of, “I just always knew I was supposed to be doing this and I never got over the hump of doing it. And now I'm just hugely relieved that I've taken some control of what my retirement income is going to look like.”

Inertia: friend or foe. There are also people where it's a much more inertia-led proposition. At some level they might be aware that this is a thing they're doing. But maybe they’re not very aware of or interested in the detail of it. With those people we would say that the fact they're doing something towards funding their retirement is still hugely valuable.

You’ve got my attention. The Australian system (which has mandatory participation) is a few years ahead of ours. What they started to find is that people engaged more once their account balances started to feel more salient. When they move from having saved a few hundred or a few thousand dollars to, perhaps a few tens of thousands of dollars, people suddenly sit up and think, well, hang on, this is an asset with real value. They start to pay much more attention to it.

So that awareness and that engagement is a slow build and that's probably right and fine. But of course, you extend something like this to 10 million people. There's going to be a lot of variation within that 10 million people about how aware or interested they are to start with, and there will be those who take a bit longer to get there.

Will, given the workforce covered and the relative youth of the program, we imagine that average account balances are still pretty modest. What's your sense of the experience for people who might be retiring out in the next 10 years and for people who have another 20 years or more to work?

Yes. So it's definitely true that account balances in Nest and across the auto enrollment system are pretty modest. Nest has about 11 million member accounts and about £24 billion of assets under management. So we're just over £2,000 on average per member in the plan, although obviously in 10 years you will see huge variation. Those who’ve been in for a long time have much higher balances than that. Those who may have come in for a few months five years ago and then gone out again to something else will have much lower balances.

When DC starts to matter. Similar to the US, our retirement system is in a transition from more defined benefit (DB) to more defined contribution (DC) plans. We're still in that phase where a lot of people retiring today are doing it using their ‘pillar one’ state pension entitlement, and some defined benefit entitlement they built up over the course of their career.

In the UK our defined contribution savings are still very much the lesser partner in that retirement savings portfolio and still feel very much like supplementary savings.

Ten years from now, people are going to be retiring without much DB left in the system and primarily relying on their DC savings.

We’re not all one size. The hope would be that by then those retirement account balances are materially higher -- recognizing of course -- and this is something we have to be really careful about in our industry – that when you democratize retirement saving in the way that you do within an auto enrollment mandate, the people you're bringing in don't look a lot like the people who were in before. Some of the rules of thumb that were true for the people who were in before don't really hold true anymore.

If you think about someone who's earning maybe £14,000 or £15,000 a year, somewhere around the national minimum wage, they're going to have a good two-thirds income replacement from their state pension.

If they're able to generate an additional thousand pounds a year or £2,000 a year from their private pension income, that's going to make a huge difference to their standard of living. The same is true if they're able to use that income as a bridge to defer their taking state pension. We're not necessarily talking about a need or an expectation for people to be building six figure sums in their DC funds to make a really meaningful difference to their quality of living in retirement.

See me. It's important that we remind ourselves of this, because our industry is so focused on: What to do when your retirement portfolio passes £100,000 versus £300,000. And that's for the most part not the people who were brought in by auto enrollment. That's a different population of people.

This is a very long-winded way of saying let's not assume that if people retire with what seem to be quite low balances that it’s not still a really meaningful lift in terms of the standard of living they can then expect in their retirement.

That’s important. We know you're passionate about emergency savings. What are some of the most important and useful things you're seeing out of the work you've done so far?

Yes, there are two important stories that are emerging in our work: one at the macro level, and one at the micro level.

At the macro level, we started out trialing voluntary opt-in emergency savings tools in various workplaces. What we found is that six in 10 or seven in 10 people would say to us, I really like this idea. I'm really open to it. I think I'd benefit from using it. But then you would lose people, all the way through the journey until maybe only 1% or 2% of people actually got around to opening up the account and paying any money into it.

The evidence for those who do use it is that it really can benefit and help them. So how do we turn that 1% to 2% up to a more meaningful number?

Can we use opt out? In the last year we have pivoted. We’ve been focusing on how to construct an opt-out version – an auto enrollment version of this emergency saving model, building on all the lessons we've had from the retirement space.

Similar to the US, it's not trivially easy for an employer to run an opt-out auto savings model, legally or regulatorily or operationally. We can say it's been a really heavy lift working with some very thoughtful and open-minded employer partners to get ourselves to a place where we had a trial that we felt was legally and operationally viable.

We launched the trial in November with the first employer. What we've seen from the very early data is that where they had something like 4% to 6% of their new employees signing up for payroll emergency savings on an opt in basis, that's gone up to 40%-plus staying in when we do it on an opt out basis. In our view this is just a hugely powerful number for liquid emergency savings.

Big improvement. To us, 40% feels like a pretty good sweet spot in terms of reaching the people who are really going to benefit from having something like this. That's also the feedback we get when we speak to people, both those who opted out and said, I think it is great my employer's doing this, but I don't personally need it, and those who stayed in.

So that's the emerging macro picture. Perhaps not a massive surprise, but with some real data behind it. It turns out that changing the default choice architecture on this thing really makes a big difference to the number of people that are going to use it.

At the micro level as we do more qualitative and quantitative research with the people in these pilots, we're getting a much clearer handle on different ways people are using their accounts.

Use Case 1. We started out with a use case in mind where people would build the balance of their account and then periodically withdraw money when some emergency occurred -- the boiler breakdown or the white goods breakdown -- to pay for that. Over time the average balance in the account would nonetheless be building. So we expected the account would see a mix of accessible emergency saving, but also asset building.

Use Case 2. We've seen that that's definitely a version of how people use it. But we've also seen two other really interesting versions. One is that people are just using this as a goal-based savings structure. They're focusing on a medium term goal, like a holiday or a deposit on a car. And they're accumulating in the account until they get there, and then taking a whole lot out in one go to meet that goal.

That's not what we had originally thought about, but it's an interesting and really valid use case. It hints, also, towards some further work on what sits between emergency saving and retirement saving; the medium term piece.

Use Case 3. The use case that's the most interesting from our perspective is this. We've seen examples of people using this account as a day-to-day or week-to-week budgeting tool or self-control mechanism. In this case they remain in, they allow this deduction from payroll on day one of the month, and quite often will use all of that money in the month.

So their emergency savings balance may get back to zero, or close to zero, by the time they are next paid. But they're in effect saving in a way that makes sure there's some money left over at the end of the month for essentials that are easy to forget at the start of the month, but are sure to happen. This might be things like a pair of shoes for the kids. If there isn't some self-control mechanism to set that money aside, and that thing happens to you a week before payday, that's when you get people hitting payday lending or other structures that are potentially more damaging.

When we speak to people in that use case, it is very clear that this is a powerful benefit to their financial health and mental health. Many in the savings industry who look at the account balance chart that sits behind that person and see it bumping along the floor near zero might be tempted to label that a failure or to label this as a person who should never have been in this thing in the first place.

And yet the day-to-day budgetary management device that this workplace emergency savings represents is hugely beneficial to those people as well.

So that's been really interesting for us, to understand at a more micro level, what some of the different use cases are for this type of tool.

We know this is a technically challenging space. Tell us how the automatic enrollment works.

Yes, let’s touch on the structure in the opt-out trial. The first thing to say is it's not quite as pure a form of automatic enrollment as you might think of in the retirement space. We do for regulatory and legal reasons have to collect some permissions from employees ahead of time around data sharing and more. In a new employee example, at the time they sign their employment contract employees give us those permissions. They join, they start work, and at the first payroll the money is automatically deducted. They do have another chance at that point to opt out if they want to.

How we do it. In this trial, the standard savings amount is set at £40 a month. Employees have an earned wage access tool, and £40 was the average amount people were drawing using that tool, so it is an evidence-based standard. Once they're enrolled, employees can change their savings amount anytime they want to. They can access the money anytime they want to, and they can opt out or cease contributing anytime they want to. So they have a lot of control. But there is a default pound amount that starts them off.

As an aside, in this case the company that we're working with is a waste management company. They use an online employee onboarding platform. When they hire someone, they send them to this platform to sign their contract and complete other new employee steps. We built in a screen and some steps to capture the permissions we needed for payroll-deduct emergency savings.

One way it’s working. What we’ve seen is that most people just click through the permissions and agree. When we ask people about that, it turns out they're pretty reassured by the message, You can opt out later. This step is just capturing the data permissions that we need.

So we haven’t seen a lot of leakage at that point, although we expected that we might. We're looking at launching trials with some other partners and we're keen to understand where employers don't have that sort of onboarding platform in place, what are the alternatives to capture permissions that still make it both viable, and workable for an employer.

At the moment you can't do this in a completely pure, automatic way without those permissions. So it's important for scalability purposes to understand additional approaches.

Let's talk about access to retirement savings before retirement, which might also tell us where the inclusion of emergency savings might be especially important.

In the UK if you are automatically enrolled into Nest or an equivalent, your point of access for your retirement savings is generally age 55 or upon retirement.

In the US we allow early access via loans, and via distributions, with tax penalties for early withdrawal. Like other countries, we provided expanded access during the pandemic on a penalty-free basis. You could say we traded some long-term financial security for short-term financial shoring up.

Yes. So there are a few things in there. As it turns out, there was very little pressure in the UK system during the pandemic to allow that access. It's possible that's because the defined contribution system is relatively immature.

Our auto-enrolled account balances are often still quite low. To some extent we may have recognized there is a danger that you'd quickly wipe a lot of those balances away to zero and undo ten years’ worth of progress on the retirement side. So that wasn't a very active debate during the pandemic really.

Proposals. Interestingly, our Association of British Insurers, the industry representative body for the insurance sector, just recently came out with proposals for the future of automatic enrollment in which they were advocating for some hardship-based early access, which I thought was interesting and a little unexpected.

My take on this would be, firstly, we have to be a little careful not to be too dismissive of the need for access. There will be some people for whom, strictly speaking, wiping out their retirement assets is a sensible short term strategy. There’s a really powerful argument that if you're about to default on your home, for example, it may be preferable to deplete your retirement assets and try to bridge the gap back later, than to lose your home. So, I'm certainly not in the business of saying I could just never see a scenario where once money's in the retirement system, that it should never be allowed to come out early.

Access? But what I would say is this: the retirement system works best when the assets that have put away for retirement are left for retirement.

Part of that is an investment argument. When, during the pandemic Australia discussed opening up some pre-retirement access, the argument got made by the Superannuation funds that there would be negative impact to portfolios and saver returns. To paraphrase, we don't want to add a lot of liquidity into the investment strategies that we've developed over the last 20 years for people's long-term retirement security. The Australian DC industry is market-leading in their use of illiquid investments. They own infrastructure, they own airports, they own rail systems, and they do that because it's a really powerful way of driving sustainable long-term returns for their members.

If you suddenly start putting the funds in the position where they need to keep a bigger liquidity buffer on hand at the scheme level, you are giving up the potential for return-seeking behavior and innovation on the investment side.

So there's a really powerful argument for trying to set your system up in such a way that money that's set aside for retirement stays set aside for retirement.

A better way. But if that means building a second account structure for emergency savings and dividing up people's capacity to contribute across the retirement account and the emergency savings account, then that may well be legitimate.

I definitely don't think we should be saying pension saving is somehow more important or sits higher in some intellectual hierarchy than short-term financial resilience. So the preferable system design may be a two account structure where pension money is for pensions and is invested as such, and where the system is also recognizing the need to help people to fund shorter-term emergencies and building products that fit that bill.

I tend to favor the ‘sidecar savings’ structure over the ‘early access to pension savings’ structure.

[include here the new PGIM research: hidden cost of early access to retirement assets]

Will, final question! What do you see as the next iteration of both automatic enrollment and savings in the UK?

Let’s start with auto enrollment. There are a couple of big debates at play in the UK. One is around our £10,000 threshold. Workers earning below this level are not automatically enrolled. Should the level be changed, removed, or lowered to bring more people in? The debate is occurring with a particular eye on part-time workers, who tend disproportionately to trend female. And therefore that £10,000 limit is seen as contributing to significant gender pensions gap in the UK. It also recognizes that people who have multiple sources of income where no single job pays them over £10,000 may be falling through the net multiple times, but actually may be earning enough for it to be very sensible for them to be saving for retirement. So that's debate one.

Debate two is contribution rates. We have a minimum auto enrollment rate of 8% of a band of earnings; part of which comes from the employee, part which comes from the employer. There's a debate about, should that number go up? If it should go up, how should that increase be distributed between employers and employees?

This is a bit technical, but the band of earnings on which auto enrollment contributions are calculated starts at about £6,000. So one thing you could do is abolish that and start calculating savings based on the first pound of earnings. But that would disproportionately increase the contribution rate of the lowest earning participants, where if you just increase the 8% limit that's going to hit the higher earning participants – so we’ve got a debate about what's the right balance.

Both those debates, the income threshold debate, and the contribution level debate, are somewhat overlaid with the cost of living situation. Our recent rate of inflation announcement put the Consumer Price Index at 9.1%. That's the highest rate it's been in 40 years.

Optimizing outcomes. There is a dawning recognition that actually, for people nearer the bottom end of the income spectrum, that is within auto enrollment nearer the £10,000 level, 8% plus their state pension may offer pretty good equilibrium, given some of the other challenges they face today.

So if the contribution rates are going to go up, how do you get them up for the right people without swamping those for whom higher levels may become too much. This gives me a neat bridge into emergency savings and what’s next there.

For us at Nest, we continue to focus on how we can help employers innovate in the emergency savings space. And there is a bit of a recognition more broadly in the industry that this may also offer a route through the challenge I've just described.

Think about this: if you are going to increase auto enrollment contribution rates for everybody, there's a reasonably powerful argument for some of the increased savings to remain liquid for people in an emergency account rather than going straight into a retirement account. It helps to mitigate some of the risk that you unintentionally force lower earners almost to save too much for their retirement relative to their living standards today.

Interestingly, the Minister for Pensions here gave an interview to a national newspaper at the weekend in which he said he would like to explore the idea of an automatic 1% of salary going into an emergency account. He didn't say this, but I interpreted that to mean potentially as part of the future of the pensions auto enrollment structure.

So those debates are beginning to meet each other in the middle.

Optimizing outcomes, part two. And then for Nest, probably the biggest single focus of our innovation thinking remains around the retirement income space. How do you build an in-plan retirement income structure that's going to work for a mass market of people with small-to-medium five-figure balances at retirement, rather than small-to-medium six-figure balances, which is where the industry has historically focused.

We continue to think very carefully about how that would work. And there's a bit of a discussion in the UK about what role is right and appropriate for Nest as a public entrant provider to play in that retirement income market, which runs in parallel to our own thinking on what the solutions ideally could look like for our members.

At one time there was a requirement to annuitize in almost all cases by the age of 75. That changed in 2014, eight years ago. Now in effect you can take your money as cash or in whatever form you like beginning at age 55.

As a result, many fewer people are buying annuities. There's some innovation in the draw down space, trying to fill the gap. But again, possibly not for those with more modest account balances and who don't have access to, or can't afford, financial advice in the same way as those a bit higher up the spectrum may be able to.

That's really where we're focused: how do you help people who don't or can’t access advice to find their way into a retirement income solution that's suitable for their needs, and that balances their desire for flexibility with their desire not to run out of money before they die.

Thank you, Will Sandbrook!

Will Sandbrook is the Managing Director of Strategy, Analytics and Nest Insight at Nest. He has spent 20 years working in strategy, public policy, research and communications roles relating to personal finance and pensions, including working for the UK government on financial inclusion policy and the design and implementation of their landmark automatic enrolment programme. In 2008 he joined Nest, shortly after it was formed, and joined the Executive Team in 2010 as Strategy Director. In 2016 he oversaw the launch of the Nest Insight Unit, which he still leads alongside responsibility for Strategy, Data and Analytics for Nest more broadly. Will has published papers on pensions policy, workplace emergency saving and financial wellbeing in the AARP International Journal, the International Journal of Pensions Management and with the World Bank, among others, as well as authoring and contributing to a number of Nest Insight reports. He has spoken at policy and industry conferences and events in the UK, Europe, Asia and North America. Outside of Nest he has acted as an independent adviser and subject matter expert on research projects for Natcen and the Behavioural Insights Team and sits on the editorial advisory board for the Journal of Retirement. He previously served as a member of the International Centre for Pensions Management’s research committee.

Want more? You can connect directly with Will by email here. You can sign up here to receive updates from NEST Insight. Connect on Twitter @NESTInsight. You can also join the recorded version of Nest's May 15 2022 Emergency Savings Summit.

This piece was featured in the July 21, 2022, edition of Retirement Security Matters. For more fresh thinking on retirement savings innovation, check out the newsletter here.