Pension reform cliff-edge will hit low earners in retirement

Proposals in the Automatic Enrolment review published this week will boost the savings of many low and mid-paid workers by applying pension contributions from the first pound of earnings.

But the government is to continue with existing rules that requires employers only to enrol those earning more than £10,000 from any one job into a pension scheme. This earnings trigger creates a steep cliff edge for those excluded from the system, the vast majority of them women.

The decision to apply pension contributions from the first pound of earnings is a victory for trade unions. Currently, the first £5,876 of an employee’s earnings does not count under automatic enrolment.

We have long argued that this makes the system complex and unjustifiably hits the savings of low-paid workers.

The changes will mean that someone earning £10,000 a year will have annual pension contributions of £800, including £300 from their employer, once minimum pension contributions reach 8% as planned. This is £300 more than is pencilled in under the current system.

Someone on median earnings of £28,213 a year will see their pension contributions rise from an anticipated £1,787 to £2,257 with employer contributions hiked from £670 to £846.

However, someone on £9,999 will not be automatically enrolled and could be denied the contributions made to the retirement savings of their better-paid colleagues. If they had been enrolled on the same terms as colleagues, they could have expected £299.97 a year in employer contributions.

This hits women particularly hard. Thanks to the earnings trigger, female workers comprise 43% of private sector employees but just 38% of those currently eligible for automatic enrolment.

The government said it will continue with an earnings trigger of £10,000, although this will continue to be reviewed annually. But if it were to reduce, to say the National Insurance Lower Earnings Limit of £6,337, it would bring an additional 1.2 million people into the eligible target group. Some 78% of this group is comprised of women.

Nevertheless, it is undoubtedly the case that automatic enrolment has been a positive pensions policy.

DWP analysis shows that in 2012, just 56% of employees earning above £10,000 were saving in an occupation pension; in 2016 this figure was 77%.

It has had a particularly dramatic impact on pension participation among lower earners and younger workers.

Even so, some 12 million people, or nearly two in five of the working-age population, are estimated by the DWP to be undersaving for retirement.

To tackle this, the proposed reforms also include automatically enrolling workers from the age of 18, instead of the current starting age of 22. This meets the TUC’s call for a lower starting age for pension saving

Despite its flaws, the package of changes should make a significant difference to savers. Applying contributions from the first pound of earnings and lowering the age limit to 18 should mean £3.8 billion more being saved in pensions every year. This includes £1.4 billion in additional employer pension contributions.

However, the government is only seeking to implement the changes from the mid-2020s. This leaves many workers with years more of inadequate savings rates.

Ministers have also dodged the question of how to raise contributions over time so that workers can expect a decent standard of living in retirement.

It remains to be seen how workers will respond when contribution rates are increased in 2018 and 2019.

Under automatic enrolment employees pay in more than their employers. This is the reverse of what has been the norm in the UK and elsewhere where employers typically at least match, and often double-match worker contributions.

This is taking place against a backdrop of continuing weak wage growth weighing on household incomes.

The success of the next phase of pension reform will undoubtedly depend on getting the economy growing again and getting more money into the pay packets of workers.