Behavioral Economics and Retirement Savings: The Success of the UK’s Auto-Enrolment Pension Scheme

Saving for retirement is a challenge for many. When we have bills piling up and new things we want to buy, we don’t always think about putting funds aside for later in life. 

That’s why the UK created its “auto-enrolment” pension scheme to encourage workers to sign up for pension plans and employers to help with contributions. 

The system has been a big success so far. Since its introduction in 2012, over 10.6 million workers have enrolled in a pension plan, meeting the goals established when it was created. (asppa-net.org, 2023)

What does the auto-enrolment scheme do, and why has it worked? A lot of it has to do with the principles of behavioral economics. Let’s analyze the key components to explain why. 

Behavioral Economics Principles Relevant to Retirement Savings

Behavioral economics is where psychology meets economic principles. It explains how human behavior affects decision-making. A handful of behavioral economic principles can be used to explain why it’s hard for us to save for retirement on our own. Those include:

  • Inertia: The concept of inertia refers to our tendency to maintain a specific course of action even when presented with new information or potential benefits from changing. It’s essentially a resistance to change or lack of motivation. So, if you aren’t saving for retirement right now, it can be hard to get the ball rolling and start doing it. 
  • Default options: This principle states that we tend to opt for the pre-selected choice. Therefore, if the default option has no retirement savings plan, more people would go with that choice. On the other hand, if the pension plan is the primary choice and it’s easy to sign up, more people are likely to select that route. 
  • Present bias: The present bias states that we tend to prioritize immediate or present rewards over larger future rewards. Essentially, it’s hard to see past what’s right in front of us. In terms of saving for retirement, that could be someone splurging for tickets to a concert with money they were planning to put aside for their retirement plan. 
  • Loss aversion: People tend to feel the pain of losing something much more intensely than the pleasure of gaining something equivalent. That’s especially true if the potential gain is far in the future. You may even feel the loss of money from your bank account now when setting it aside for retirement much more intensely than the relief of having it there to support you later on. 

All these principles show why saving for retirement can be difficult for many people. That’s why the UK auto-enrolment pension system is beneficial. 

How the UK Auto-Enrolment Pension Scheme Works

The auto-enrolment pension scheme is a mandatory workplace pension system. Under its guidelines, employers must automatically register eligible employees for it unless they choose to opt-out. 

Employees typically become eligible when they turn 22 and are earning more than £10,000 per year. 

Under the Pensions Act 2008, employers are required to offer an automatic pension plan with a minimum combined contribution from the employer and employee of 8% of qualified earnings. Employers must contribute at least 3% while the employee contributes the remaining 5%. (legislation.gov.uk, 2008) 

It essentially motivates employees to sign up and makes it easy for them to do so, with employers playing a key role in the process. 

Impact of Behavioral Economics on Auto-Enrolment

Behavioral economics has a key role in the success of this system. 

First, it creates inertia. Employers must offer the plan, and employees are automatically enrolled unless they opt out. Therefore, it gets the ball rolling on employees contributing to a retirement plan without much effort. Not to mention, it’s the default option for them to choose, so they’re more likely to take it. 

It also counteracts the present bias and loss aversion. Automatic deductions are made from paychecks, making them less noticeable than physically clicking a button each time to deposit to a pension. Plus, it leaves you without the money in hand to splurge on other items rather than contributing to your savings account. 

Impact on Retirement Savings Rates

As mentioned earlier, the auto-enrolment system has been a big success. One of the major issues policymakers wanted to address with this system was the disparity in pension plan enrollments between high-income and lower-income employees. 

In 2012, the disparity between pension enrollments for employees earning £10,000-20,000 annually and employees earning £60,000+ annually was 49%. By 2021, it was estimated that the gap had fallen to 11%. 

Additionally, enrollment rates for employees in the private sector increased from 42% to 86%. 

Conclusion

The success of the auto-enrolment pension scheme shows a key point. Policymakers need to account for human behavior when creating systems. When the psychology of decisions is considered, it’s much more likely that plans like this can achieve their intended outcomes. 

It’ll be worth watching the UK’s auto-enrolment system in the future to see if any elements need adjustment and how it helps the average worker later in life. 

And if you’re in a country or situation that doesn’t have an auto-enrolment system like this, consider starting to save for retirement right now if you have the means to do so. Think of this article as the boost of inertia you need to get started and out of the rut of present bias. Your future self will thank you later.