The “hidden” calculation eroding savers’ auto enrolment pension pots

It is good to see the Pensions Minister attempting to tackle the issue of low paid, part-time, mainly female workers missing out on state pension benefits. It is now time for the same logic to be applied to the way low earners are hit by auto enrolment qualifying earnings rules.

State pension reform and auto enrolment are meant to be working hand in hand to deliver a decent retirement to the nation’s workers. Both currently exclude low earners from pension provisions, including the many who have multiple jobs that would, when taken together, be sufficient for them to qualify for pension benefits.

The Government is right to be looking for ways to improve the situation of low earners currently excluded from the new flat-rate state pension. Department for Work and Pensions’ figures from 2014 show there are around 40,000 people, 30,000 of whom are women, who are not accruing state pension because their earnings are below the qualifying threshold, but who would do if all their combined wages were added together. Pensions Minister Ros Altmann is understood to have asked officials to look at ways of helping low paid part-time workers to build up entitlement under the state pension system.

Qualified earnings rules penalise low earners

But nothing is being done to address the far greater number of low earners that are being penalised by the auto enrolment qualifying earnings rules that sees employer and member contributions only paid in relation to earnings between £5,824 and £43,000 a year.

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.

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.

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. A pharmacist earning four times as much – £40,000 – gets a contribution more than eight times higher of £2,734.08.

What should be done instead?

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 and the pharmacist’s to £3,200.

It is widely accepted that even 8 per cent of all earnings will not deliver the retirement income most Britons are expecting. A recent paper by the Association of Consulting Actuaries called for a gradual phasing of contributions to between 14 to 16 per cent, arguing that even after 40 years of contributions at 8 per cent of band earnings, a person on average earnings will fall markedly short of the Pension Commission’s targeted replacement income of two-thirds of pre-retirement income.

We agree that in the longer term, increased contributions on this scale will be needed. But as a very first step the Government should use the 2017 auto enrolment review to sweep away the qualifying earnings rules. That would go some way to restoring fairness to the system and ensure that an 8 per cent contribution means precisely what people think it does.

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