How often do we say ‘when I have a bit more cash I’ll put it into my pension’? We all know that we need to save as much for retirement as possible but in reality when it comes to it we find something more pressing to spend the money on. In his speech to the CISI Financial Planning Annual Conference Royal London, director of policy Steve Webb called for a ‘Save More Tomorrow’ scheme, also known as ‘SMarT’, to be implemented and legislated for in the UK. This idea is not new – but is one that has not yet caught on in many UK occupational schemes.
As the former pensions minister explained, the schemes ensure that, when someone receives a pay rise, they pre-commit to placing a higher proportion of their earnings in their pension than they currently do. He said there was “very clear evidence” this type of scheme works, adding it was “very effective” in the US. The scheme – designed by Richard Thaler, professor of behavioural science at the University of Chicago Booth School of Business, and Shlomo Benartzi, a professor at the UCLA Anderson School of Management – allows workers to allocate a portion of future salary increases towards their retirement savings. They explain how this idea uses principles from psychology and behavioural economics to devise a program to help people save more. In principle an employee might opt to allocate 50% of any future salary increases to their pension plan – meaning that, should they have a pay rise of 2% in any given year, half of this would go into their wage packet and half into their pension. The psychological effect is that, importantly, workers do not see any fall in their take home pay as a result of this programme, merely a slightly smaller increase.
As the authors explain in the paper: “One reason why the SMarT plan works so well is that inertia is so powerful. Once people enrol in the plan, few opt out. The SMarT plan takes precisely the same behavioural tendency that induces people to postpone saving indefinitely (i.e., procrastination and inertia) and puts it to use.”
Steve Webb suggested it could remain on P60 records so that, if or when people change jobs, they start from where they left off at their old job and continue to build up their pension contributions as they earn more money.
Until such time as the Government gets behind the SMarT plans, could the principles outlined here be used in a less formal setting (perhaps at annual review) by financial advisers to encourage clients to increase their pension contributions? Learning to see 50% of any additional income as already ‘committed to the pension’ might be a useful tactic to avoid procrastination.