How to quantify the value of additional pension contributions

The introduction of pensions auto-enrolment saw large numbers of employees start participating in something they did not necessarily understand, and were not always engaged with. On the other hand, it has led many to believe that their retirement savings are fully taken care of, which is far from the truth.

Stuart Price, partner and actuary at Quantum Advisory, says: “My rule of thumb is that, if [an employee] wants a really decent pension, then the total amount being saved each year should be half [their] age, [but] just by changing contributions by 1% when [they’re] younger can have a huge effect on the financial result.”

So, how can employers engage staff with the idea of giving up even more of their hard-earned wages, for a goal that is often in the distant future?

The deal on the table

For many employees, monthly pension contributions are viewed in the same way as tax and national insurance (NI) contributions as cash being removed from their pay packet. But employees need reminding that the money is theirs; while they cannot access it immediately, it is theirs and it will remain theirs, says Steven Cameron, pensions director at Aegon.

Once pensions are correctly framed alongside other savings vehicles, such as individual savings accounts (Isas) or the Lifetime Isa (Lisa), the benefits of contributing more can be better communicated. “One of the really powerful ways of helping people to understand what a good deal it is, is to show them what the net cost is, how that is added to from employers and tax relief, [and] show [that they] won’t get a better deal than that anywhere else if they want to save for the future,” says Cameron.

Part of this process is reminding employees of the other elements at play, says Price. “People don’t appreciate that pension contributions aren’t as costly as [they seem],” he explains. “After tax relief, the cost to people is much lower. A 5% employee contribution rate actually costs 3.4% for a lower-rate tax payer. It’s making that clear to people, and reminding them that their employer is paying in as well.”

Another effective method of encouraging employees to add to their own contributions is by offering a matching scheme and pitching it as the opportunity to double their money.

Helen Morrisey, pensions specialist at Royal London, says: “When [looking] at how much [employees] need to save for retirement, it’s often quite a scary number and can put people off, but what people don’t realise is that it’s made up of their contribution, tax relief, and employer contributions.

“When you look at it with that view, the big scary number isn’t quite as scary any more. And at the end of the day, it’s free money.”

Breaking down the costs

Understanding the benefits of increasing contributions is only part of the process. For many, retirement is far off, saving enough seems insurmountable, and immediate financial concerns feel more pressing.

Cutting through the complex jargon and percentages to get to more understandable terms for the individual can also help, says Nathan Long, senior analyst at Hargreaves Lansdown.

“We would boil it down to the monthly cost of paying in more,” he says  “Use worked examples on a pounds-and-pence basis to show this is a good idea and [employees] are getting a lot more for [their] money than [they would if] getting it back in [their] pay packet.”

In some instances, particularly for younger employees for whom retirement is further away, making the costs seem more achievable might not be enough. Employers could, therefore, break down the final goal into more manageable chunks, says Cameron.

“One of the ways of showing the value month by month is to celebrate when people achieve certain fund levels,” he explains. “Say to people: ‘you’ve now joined the £5,000 club’. Anything we can do to make it more relevant today has to be a good thing.”

Creating shorter-term milestones not only pushes engagement, but also asks the employee to think of their retirement savings as a very real pot of money that they are already successfully saving into.

Reminding staff that having a pension makes them investors also frames this as an active rather than passive vehicle, and asks staff to really consider what they can do to help their money go further, says Morrissey.

Cups of coffee

Helping employees understand that small increases can have a large impact can also be a matter of showing those contributions in comparison to everyday purchases. A common example is relating monthly costs to the number of coffees their contribution equates to, compared to the pay-off come retirement.

However, there are some potential pitfalls to doing this, says Long. “The worry is [employers] could be seen to be patronising,” he explains. “What [we’re] trying to sell [staff] on is that [they are] getting an awful lot in [their] pension for not much cost, as opposed to ‘it only costs this’. If I spend £20 on coffee a month, it’s because I want to.”

This also risks linking pension contributions to the idea of giving something pleasurable up in the present, which is itself disengaging.

The answer to this issue might be to encourage staff to streamline other payments, such as car insurance or utilities, and use the remainder to top up their contributions without sacrificing everyday cash flow.

Making retirement real

For many, the issue with letting go of funds now, even when the cost is manageable and the benefits clear, is simply in feeling that the end point is too far off to be relevant. Employers should, therefore, frame communications around the realities of retirement.

Using Office for National Statistics (ONS) data, for example, employers can map average daily living costs against employees’ projected retirement earnings, and demonstrate the difference made by additional contributions now.

One option is to look at the state pension as a starting point, and highlight that employees will not be able to rely on it to provide a good level of retirement income, says Price.“It’s a bit of a scare story, really,” he adds.

However, this again runs the risk of putting a negative spin on pension savings. In the end, the employee might feel too overwhelmed and bury their head in the sand, particularly if saving means giving up on highly valued lifestyle perks in the present.

It is, therefore, also important to link those enjoyable experiences now with lifestyles in retirement. “When you retire, you want to enjoy it, so [employees need to] start saving money now so [they] can go off and do those things [they] always wanted to do,” Price explains. “What you don’t want to do is turn people off, even [saving] a little bit is better than nothing.”

As Morrissey concludes: “It’s more about bringing tomorrow into today. It’s easy to put off until tomorrow, but anything that can make [retirement] tangible to [employees] will be really helpful.

“People shouldn’t feel like they’re giving something up. A pension is an investment in [their] future self; [they’re] not giving anything up, [they] are getting something in the future.”