Adrian Boulding, Director of Policy, NOW: Pensions
When it comes to auto enrolment, there are a number of quirks in the legislation. One of these is the fact that auto enrolment minimum contributions aren’t based on every pound of earnings.
This means that while you might think you are contributing 5% into your pension, in fact, you’ll be contributing considerably less due to the way auto enrolment minimum contributions are calculated.
How does the calculation work?
Auto enrolment minimum contributions are calculated on a “band” of earnings specified by the government and reviewed every tax year.
For the 2018/19 tax year the band is between £6,032 and £46,350 a year. This means the first £6,032 of an employee’s earnings does not count for the purposes of auto enrolment nor do any earnings over £46,350.
So, for somebody earning £10,000 their auto enrolment contributions are calculated on just £3,968 of their earnings. That means that even when auto enrolment is fully rolled out they won’t receive 8% of their salary paid into their pension but just 3.2%.
Whilst the lowest earners – who are more likely to be women and part time workers – proportionately lose out the most, all savers lose out. Even somebody earning right at the top of the earnings bands at £46,350 will still receive just a 6.9% contribution as this infographic shows.
Employers can choose to make contributions on every pound of earnings if they want to. But, in most instances, employers opt to do the minimum. As a result, the vast majority of auto enrolled savers are affected by the qualifying earnings quirk although most have no idea.
Savers are in the dark
Research we carried with auto enrolled savers revealed nearly two thirds (63%) are unaware that minimum contributions only apply to qualifying earnings. Almost half (46%) of UK workers who have been auto enrolled into a workplace pension say they are contributing the minimum and, when made aware of the qualifying earnings calculation, more than half (57%) say they would prefer their pension contributions to be paid on every pound of their salary to increase the amount that goes into their pension pot.
Why does this matter?
For a number of years, we’ve been making the case for auto enrolment contributions to be paid on every pound of earnings. The reason for this is simple, over a lifetime of saving, calculating contributions on a qualifying earnings basis has a deeply corrosive effect on savers’ pension pots.
A report by the Pensions Policy Institute commissioned by NOW: Pensions revealed that at the National Living Wage level (NLW) 8% of band earnings is less than 4.5% of total earnings.
Paying contributions of 8% of total earnings would cost an employee, who works full-time at NLW, an additional £4.50 per week, with a total of £9 per week extra going into their pension pot (made up from employee, employer and tax relief). The additional saving could result in an additional £29,000 (87%) into the final pension pot.
Individuals who have taken a seven year career break and worked part-time for a while before coming back to full-time work until the end of their career, could increase their pension savings by £10,000 (86%) by basing pension contributions on every pound of earnings.
One of the recommendations of the 2017 auto enrolment review, published in December last year, was that the lower earning bands should be removed in order to improve outcomes for savers and simplify administration for employers.
The timescale for implementation of this change is still to be confirmed although the report states that it hopes to introduce this reform by “the mid 2020s”.
We are delighted that the government agree with us that the lower earnings band needs to go, but we’d like the timetable for change to be faster. Each month, auto enrolled savers are being short changed and it’s the lowest earners who are missing out the most.
If we all agree that change needs to happen let’s grasp the nettle and get it done.