High-risk default investment strategy will result in high dropout rates

[Colm Fagan]

How many of the workers who join the Irish auto-enrolment scheme will stay to retirement? According to the https://www.linkedin.com/company/the-irish-times/ (The Irish Times) of 27 June, the Department of Social Protection expects 90% to stay in the scheme long-term. That is a pipedream. The proportion contributing to retirement is likely to be less than 5%.
Of the 800,000 expected joiners, less than 40,000 will keep contributing to retirement. This sobering statistic is based on an analysis of the UK's NEST scheme, on which the Irish scheme is modelled. The table below, taken from NEST's 2023 report, shows that the scheme had 12m members, but only 4.8m (40%) were active; the other 7.2m (60%) were inactive. That is after just 6 years' membership on average. This equates to a dropout rate of 15% a year. This is a statistic that NEST doesn't highlight.
One of the reasons for NEST's high dropout rate is the shock to workers of seeing the value of their pension falling in tough market conditions. That is particularly true for people with no experience of investing or who don't have a financial adviser to calm their nerves when the going gets rough. The vast majority of Irish AE members will have no experience of investing and won't have an adviser to reassure them when markets are down.
The default investment strategy for Ireland is much riskier than for the UK. Under Section 70(4) of the Bill, 100% will be invested in a high-risk fund (risk category 5, 6 or 7) until age 51 for workers opting for the default investment strategy (expected to be close to 99%). A standard equity fund is risk level 4 to 5. Bitcoin is risk level 6, so the high-risk fund could be even riskier than Bitcoin!! In contrast, NEST starts dialling down the risk from under age 30.
It follows that dropout rates for Ireland will be higher than the UK. Assuming a dropout rate of 15% a year for the first 10 years, falling to 5% a year thereafter, only 4% of workers joining at age 25 will still be contributing by retirement. So much for the Department saying that 95% will stay in the scheme long-term. Why doesn't it tell the truth, that only 4% will stay the course, rather than try to sell a fairy tale?
PS: Has the DSP ever made clear to lawmakers the risky nature of the Bill's default investment strategy? I only noticed it by accident.

 

[Savvy]

the table below, taken from NEST's 2023 report, shows that the scheme had 12m members, but only 4.8m (40%) were active; the other 7.2m (60%) were inactive.

We'd need to understand what happened to those 7.2m? For instance have they left the country/ returned to education/ now childrearing / in other occupational schemes,etc. or have they simply opted out of the pension schemes.

 

[Dr Strangelove]

The table below, taken from NEST's 2023 report, shows that the scheme had 12m members, but only 4.8m (40%) were active; the other 7.2m (60%) were inactive. That is after just 6 years' membership on average. This equates to a dropout rate of 15% a year. This is a statistic that NEST doesn't highlight.

I don’t want to split hairs but it’s not clear from that graphic that the inactive will never return.

Lots of people (especially at less-skilled end) drop in and out of employment to care for kids, elderly relatives, go back to college, travel the world, etc.

An extrapolation from the UK experience to :

The proportion contributing to retirement is likely to be less than 5%.

is likely to be far too pessimistic.

 

[Colm Fagan]

We'd need to understand what happened to those 7.2m? For instance have they left the country/ returned to education/ now childrearing / in other occupational schemes,etc. or have they simply opted out of the pension schemes.

Lots of people (especially at less-skilled end) drop in and out of employment to care for kids, elderly relatives, go back to college, travel the world, etc.

I take both your points and I agree that my extrapolation may be too pessimistic. On the other hand, the DSP's projection that 90% will stay the course is ridiculous. This is something that they or the Pensions Council, which advises the Department on pensions policy, should be investigating in detail.
I am still convinced that the Bill's default investment strategy of investing 100% in high-risk funds to age 51 and leaving members completely exposed to the vagaries of market values, with no smoothing of returns, is a recipe for disaster.
Advisers play a valuable role in helping clients to stay the course in tough market conditions. Customer services staff in financial institutions discharge a similar role of reassuring nervous scheme members. There will be no-one to discharge that role for AE members. The need will be all the greater, given that the vast majority will have no experience of stock market investing nor of the volatility of investment returns that's part and parcel of that world.
Workers progressing in their jobs and going into higher tax brackets is another complication again for Ireland, which doesn't apply in the UK, which will lead to higher lapse rates.