The Department for Work and Pensions is shortly to begin work on the 2017 review of auto enrolment and has been asking the industry for its views on the areas the review should look at.
While in some respects it seems strange for the review to take place before auto enrolment is fully rolled out, there is a statutory requirement for government to conduct a review during 2017 to examine how auto enrolment has gone so far and how it can be improved going forward.
For us, there are a number of areas we believe the government needs to focus on to safeguard the long term success of the policy.
Removal of qualifying earnings
Qualifying earnings are the band of earnings on which auto enrolment minimum contributions are calculated and for the 2016 / 2017 tax year the band is between £5,824 and £43,000 a year. This means the first £5,824 of an employee’s earnings does not count for the purposes of auto enrolment and anything above £43,000 isn’t included either. Check out our infographic which explains this more clearly.
That means for someone earning £10,000, 8 per cent of qualifying earnings is just 3.4 per cent of actual earnings, while for someone earning £20,000 it means just 5.7 per cent. Even someone earning £40,000 only contributes 6.9 per cent through auto enrolment, while someone on £60,000 sees just 5 per cent of real earnings going into their pot.
|Annual salary||Pensionable earnings||Auto enrolment contribution taking into account the impact of qualifying earnings|
Employers are free to pay more than the auto enrolment legal minimum, but our experience is that 94 per cent do not.
The qualifying earnings rules mean a part-time shop assistant on £10,000 sees a total annual contribution of £334.08 go into their pot.
We believe the Government should sweep away the qualifying earnings rules and instead base contributions on all earnings. That would boost the shop assistant’s contributions to a more meaningful £800 a year.
Consider the trigger
When automatic enrolment started in 2012, Government took the decision to exclude low earners, unless they specifically asked to join their employer’s pension scheme. Behind this decision was the advice the Government received to avoid very small contributions, as people with only a few pounds, or in some cases only a few pennies, could have damaged the credibility of the whole auto enrolment initiative.
The result is that while over 6 million people have been auto enrolled, around 5 million people have been assessed and excluded. Many of these are part-timers who could be being unfairly penalised.
At the moment you can have several part time jobs that together pay more than the £10,000 trigger but you won’t be auto enrolled by any of your employers. But now that auto enrolment is an established success it’s time to think again. We should find a way to bring into the fold the 6 million people that are currently missing out. The obvious answer is to remove the earnings trigger altogether, and bring in everyone over age 22. But, careful consideration needs to be given to how any change would interact with means tested benefits.
Sort out the net pay anomaly
However, lowering the trigger will exacerbate the net pay anomaly.
Just to re-cap, there are two ways that pension schemes can collect the tax relief savers benefit from when contributing to a pension – ‘net pay’ and ‘relief at source’.
In common with the majority of trust based pension schemes, NOW: Pensions operates a net pay arrangement which means that pension contributions are collected from earnings before income tax is calculated and applied. This means for taxpayers, full tax relief at the highest rate is automatic and no income tax is paid on the money being contributed to a pension.
The alternative system is called relief at source. Here, employers take 80% of an individual’s pension contribution from their take home pay, i.e. after income tax has been deducted. The tax relief is then reclaimed from HMRC by the pension scheme, who send in a monthly request and get the cash back about six weeks later. HMRC only sends back the basic rate of tax, namely 20%.
Where an employee in a scheme operating relief at source is a higher or additional rate taxpayer they can claim back the rest of the tax relief themselves from HMRC either by writing to them separately, or through their annual self-assessment tax return.
In a net pay arrangement, employees that don’t pay income tax, do not get tax relief on their pension contributions from the government.
In relief at source schemes, all savers receive tax relief even if they don’t pay income tax. The government need to work with the Treasury and HMRC to address this inequality, as all savers should be treated equally, regardless of the scheme they are in.
Rebalance contributions to minimise opt out
When auto enrolment minimum contributions start increasing, there is an expectation that opt outs will increase.
Research NOW: Pensions recently conducted shows nearly a quarter (24%) of auto enrolled savers say they “definitely will” or “might” opt out, when minimum contributions hit 8% of qualifying earnings in 2019.
But, nearly three quarters (74%) of those that intend to opt out when contributions rise to 8% say they would either “definitely” or “probably” continue to save into their workplace pension, if contributions were re balanced and employers put in a minimum of 5% with a 3% staff contribution.
In Denmark it’s common practice for employers to contribute two thirds of their employee’s pension contribution with the employee contributing one third.
At the moment the “buy one, get one free” message is a compelling one but over time this is set to be diluted and this inequality could drive opt outs.
Set the road map for increasing contributions beyond 8%
Eight years on from the Pensions Bill which brought auto enrolment into being, savers are still only contributing 2% of qualifying earnings. It’ll be 11 years from the 2008 Pensions Bill when savers begin contributing 8% of qualifying earnings.
Very few experts believe that 8% is an adequate contribution. And one of the important lessons we are learning from auto enrolment is that when Government set a minimum level of contribution, that’s what nearly everyone ends up paying. There seems to be an implicit assumption amongst both employers and employees that if Government took the trouble to mandate a minimum contribution in legislation, then it must be adequate. By the time they find out it isn’t, it will probably be too late!
Government should set a road map for increasing contributions to a point where people will be able to enjoy the same the sort of standard of living in retirement as they did in their working years. It would be a bit sad if you could no longer afford satellite TV channels just as you get enough time to watch them all!
We should follow the Australians. They have mandatory contributions and have laid down a road map to increase them to 12% by the year 2025. The reason that’s such a long plan is that they are getting there is tiny, baby, steps. Annual increases will be just ½% a year. But with low inflation now baked into the economy, we feel it’s better to take time and get there in small steps, rather than trying to rush forward and maybe losing people along the way.