Paul Lewis: Why auto-enrolment will not mean auto-enrichment

Auto-enrolment will produce much less than the state pension at the end of a working life

 

Suddenly millions more are paying into a workplace pension. The number contributing to a private defined contribution scheme at work was fairly stagnant for years, at around one million. But then, in 2014, it started growing. By 2016, it had reached 6.4 million.

The rise is due to automatic enrolment. Just about every employer now has to have a pension scheme in place and automatically put its workers into it.

Good news so far. But other figures in the latest Occupational Pension Schemes Survey from the Office for National Statistics are much less encouraging. The average amount going into those schemes in 2016 was just 4.2 per cent of pay. That is less than half the 9 per cent average in 2013 before auto-enrolment began, and less than a fifth of the 22.7 per cent being paid into defined benefit schemes. If less than a fifth is going in, then less than a fifth will be paid out in pensions.

There is a glimmer of hope. The amount going into DC schemes has ticked up from 4 per cent in 2015 (though when I asked ONS why that 0.2 percentage point rise had happened the answer was it might just be “sample variation”).

Pensions minister: ‘No doubt’ auto-enrolment will reach self-employed

The detail shows employer contributions rose from 2.5 per cent to 3.2 per cent while the average employee’s contribution fell from 1.5 per cent to a record low of just 1 per cent.

These depressing figures reflect the diluting effect of the very low contribution levels set by the Government for auto-enrolment. This year, the nominal amount is 1 per cent each from employer and employee. In practice, it is a lot less: just 1.2 per cent in total for those on the national living wage.

Contributions will rise in April and then again a year later to what the government calls 8 per cent – split 5 per cent from the worker and 3 per cent from their firm. Except it is not. These percentages are applied to a band of earnings which this year runs from £5,876 to £45,000. So for those on low pay, the percentage of their total earnings being paid in is much less.

That 8 per cent of the band cannot possibly provide more than 7 per cent of total pay and that is only achieved by someone earning £45,000. A person on median pay of £26,260 will have just 6.4 per cent of total pay paid in. And the group who auto-enrolment was really intended to help – those on low incomes – will get less still.

Robo firms struggle to enter auto-enrolment market

A person earning the national living wage of £7.50 an hour working 37.5 hours a week will have just 4.8 per cent of their pay going into their pension. That includes the modest subsidy from taxpayers of £70 in the year. Compare that with the subsidy given to someone paying top rate, 45 per cent tax. If they pay £10,000 from their net earnings into a pension, they get it topped up by a gift from the Treasury (you and me) of £8,182.

These tiny amounts going in – just £700 a year from someone on the national living wage – are not going to buy much of a pension. Today, a healthy 65-year-old would need around £260,000 to buy an annuity equal to the index-linked new state pension of £8,297 a year. How long would someone have to pay into an auto-enrolment pension to have that much at 65?

Time for a spreadsheet – and some assumptions. First, the employer joins the Nest scheme. That levies an initial charge on each contribution of 1.8 per cent and then a 0.3 per cent annual charge. That is cheaper for periods over 10 years than the average 0.64 per cent annual charge, with no initial charge, of the other master trust schemes listed by The Pensions Regulator.

Second, the fund grows at 4 per cent a year before charges. Third, scheme pension age is 65 and the starting age is 22.

Paul Lewis: The end of advice as most know it

Forty-three years saving full auto-enrolment contributions into the Nest scheme would only achieve £260,000 if the employee earned £36,500 – about 1.4 times the median. Someone on median pay would get just £173,200, only enough to buy an index-linked pension of £5,600 a year. Someone earning the national living wage would have just £74,300 in their pot and could buy a pension of £2,400.

One reason the amount is so low is that employers are getting pensions on the cheap. Auto-enrolment reverses the ratio between employer and worker. It is the workers who pay the bigger share of the contributions – a ratio of five to three. Until auto-enrolment, it was the other way round: the average 9 per cent paid into DC pensions was divided roughly two to one between employer and worker.

Full auto-enrolment contributions paid by an employer for a worker on median pay will be just 2.3 per cent of total pay. That falls to 1.8 per cent for those on national living wage. Compare that with the 16.9 per cent paid in by firms with a DB scheme. Not to mention the 54.6 per cent contribution paid by the Bank of England for some of its staff.

The one change that would most help people achieve a decent pension in retirement is employers paying in twice as much as their employees, as used to happen before auto-enrolment.

Not all employers want to pay even 1.8 per cent. The auto-enrolment review – which will report to Parliament by the end of the year – has been lobbied by the Confederation of British Industries and National Farmers Union to exempt farmers and other employers from the “unnecessary burden” of auto-enrolling seasonal workers.

So not only do farmers build without planning permission, pay no inheritance tax and get a tax-free subsidy of £215 for every hectare they own, they now want to employ a person on the minimum wage and not pay into a pension for them. At current rates, that would only cost them £87 a year. Or, as farmers call it, an acre. Cheap indeed.

Paul Lewis is a freelance journalist and presenter of BBC Radio 4’s ‘Money Box’ programmeYou can follow him on Twitter @paullewismoney

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Comments

There are 6 comments at the moment, we would love to hear your opinion too.

  1. Many years ago, someone showed a slide which stated the problem in simple terms. You work for 40 years, and are retired for 20 years – half your working life. The maximum pension you could have is 2/3rds final salary. How much of your working life income over 40 years should you put it to get that 2/3rds pension? (Ignoring inflation, KISS etc.)
    Answer? 1/3rd. 33.3% – note you have the same level of income throughout your life.
    Makes the point well – you should put far more into your pension than the current levels of contribution.
    Nevertheless, the real issue is perhaps that most people (and employers) cannot afford the ideal levels of contribution.

  2. Auto Enrolment is a complete scandal, Its been miss sold its miss leading and a total waste of money, Ask the member, who is the scheme with, what funds are being invested with, and worst of all, what are the charges, got the answer, Yep as I thought, they have no idea, Its obfuscated abuse of the public’s gullible stupidity Its a disgarce

  3. “A person earning the national living wage of £7.50 an hour working 37.5 hours a week will have just 4.8 per cent of their pay going into their pension. That includes the modest subsidy from taxpayers of £70 in the year. Compare that with the subsidy given to someone paying top rate, 45 per cent tax. If they pay £10,000 from their net earnings into a pension, they get it topped up by a gift from the Treasury (you and me) of £8,182.”

    Interesting use of language. It’s a ‘modest subsidy’ when it’s someone on the living wage but a ‘gift’ for those earning more. The reality is that ‘gift’ is a small part of the total they have contributed to the Treasury coffers so that seems fair and reasonable if everyone is treated the same.

    At its core this article seems to be saying nothing more complicated than higher earners should pay more tax. That’s a valid argument but it should be made openly not hidden in a debate about pension tax relief.

    Lastly, is the dig, and sweeping statement, about farmers really necessary in a purportedly serious article? It’s as relevant as me saying that all journalists are rabble-rousers with their own personal agendas dressed up in writing as independent thought and opinion…

  4. Not exactly rocket science this article – basically tells us that the less you put in to a pension the less you get out. Surely encouraging people to save tax-efficiently for their retirement so they don’t have to rely solely on the state pension is a good thing?!

  5. Robert Milligan is quite right. Members in these plans are treated disgracefully.

    But AE was not supposed to be a real pension. It was designed to reduce benefit payments and enable the Government to continue to pay the most parsimonious State Pension in the whole of the OECD.

    In my opinion a far better solution would have been to charge a nominal amount for NHS services. Say £10 for a GP (excluding the young & the unemployed etc.) and a nominal amount for food when in hospital (Say £3 per day). You would have to eat when at home.

    The money saved could go towards paying a better State Pension which could be somewhat means tested. (E.G. For anyone with a retirement income of over £50k – no State Pension) What is paid by employers into this woebegone AE scheme could be diverted directly to the NHS.
    This I would have thought could solve or at least ameliorate two problems at once.

    I admit there is a downside. Advisers, fund managers and providers would squeal!

  6. Paul seems to be forgetting two minor details in his comparison of low and high earners: –
    1. Anyone paying 45% tax is going to be subject to the Tapered Annual Allowance, and so might be limited to a maximum contribution of £10k gross (not net) and this will probably have been paid by the employer as well so they won’t be receiving any “gifts” from the Government.
    2. Many of these same high earners, and even many 40% taxpayers, will probably not be funding into a pension at all because they have reached one of the Lifetime Allowance limits and have opted for protection and stopped paying in!

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