AE review: Welcome reforms not due until mid-2020s

The government has extended auto-enrolment to 18-year-olds, which will bring 900,000 young people into pensions saving as part of its review of the UK savings landscape.

The statutory review of auto-enrolment, due to be presented to parliament on Monday, will also remove the earnings bracket currently used to calculate contributions, and will test what it calls “targeted interventions” with the self-employed.

However, savers will not feel the effects of the new policies until the mid-2020s, when the policies will be introduced, with the Department for Work and Pensions saying it wants to give businesses and savers time to plan.

Despite the introduction of auto-enrolment in 2012 being hailed almost unanimously as a success of government policy, concerns have been mounting over groups left out of pensions provision, and dangerously low rates of saving in the UK.

The DWP has largely sidestepped the question of future increases in the review, delaying consideration of minimum contributions until 2019, when the current schedule of increases has been implemented. Instead, it is increasing contributions indirectly by removing the lower earnings limit.

Two of the three key changes are aimed at bringing more people into auto-enrolment.

Secretary of state for work and pensions David Gauke said in a statement: “We are committed to enabling more people to save while they are working, so that they can enjoy greater financial security when they retire.”

Saving to start earlier

With 9m people now enrolled into a workplace pension, the lowering of the starting age to 18 will add another 900,000.

Currently, the age at which employers must start enrolling employees into a pension is 22, but many have commented on there being little logic to using this age as a starting point.

It’s absolutely true the self-employed are a very diverse group but that doesn’t mean there aren’t very powerful things you can do

Steve Webb, Royal London

The decisions came as an unsurprising yet welcome announcement. Nathan Long, senior pension analyst at platform provider Hargreaves Lansdown, said bringing the age down to 18 has “been widely talked about already”.

He said: “The fact that we’ve got people saving earlier is… very good in terms of their long-term position.”

However, younger workers tend to be more transient and undergo the most job changes. “That’s going to bring loads of small pension pots into existence,” and this might cause problems for individuals regarding their ability to manage this, Long noted.

He added that it would make the role of the pensions dashboard, due in 2019, even more crucial in terms of enabling people to keep track of their savings.

Consolidation might be necessary

Darren Philp, director of policy and market engagement at mastertrust The People’s Pension, emphasised the fact that “within defined contribution pensions, the earlier you start saving, the better, because then you can let investment growth do more of the heavy lifting”.

He commended the announcement as “a really good, sensible move”, and agreed that “the small pots issue is an issue we’ve got to deal with and address, almost outside of this review”.

Source: Hargreaves Lansdown. Based on earnings of £28,000 a year increasing in line with inflation, net investment returns of 5 per cent. Pot sizes are in today’s terms. Where the qualifying earnings reduction applies (currently £5,876) this also increases in line with inflation.

The important thing is getting people saving early, and getting into the habit of saving, Philp said, noting that there are small pots all over the system anyway.

He cited several different potential solutions to solve the small pots problem, including some form of auto-consolidation, or a system in the future whereby “it is the individual that chooses the scheme, rather than the employer, so it’s more like a bank account”.

Tax return nudges ditched

One group of people the government does not have a simple answer for is the self-employed.

“There is no one uniform solution,” a spokesperson for the DWP explained, because the self-employed are such a diverse group.

Self-employed workers can span wealthy small business owners to participants in the gig economy with little disposable income. The cohort often exhibits volatile levels of income and expenses, which might make a schedule of regular contributions difficult to implement.

What the government has set out in policy is a series of “targeted interventions”, aimed at influencing self-employed behaviour at the point of contact with institutions like banks and companies that contract labour.

Details of these interventions are few and far between, and solutions will have to be tested before they can be implemented.

The initiative was therefore branded “deeply disappointing” by former pensions minister Steve Webb, now director of policy at provider Royal London. He called the mid-2020s timetable “a shocker”.

“It’s absolutely true the self-employed are a very diverse group,” he said. “But that doesn’t mean there aren’t very powerful things you can do.”

Has DWP bowed to political pressure?

Prior to the review, Webb and others had suggested introducing nudges and default pathways into self-assessment tax returns.

The government spokesperson said the department was still considering this, with the possibility that it could be implemented as part of its drive for the digitisation of the tax system.

But Webb suggested the plans may have been met with opposition from HM Revenue & Customs and the Treasury, whose own policy the move would have necessarily interfered with.

However, some elements were welcomed. Webb accepted that implementing a nudge system in companies that contract labour might benefit gig economy workers, where the companies are “in effect their employers”, made sense.

And Philp welcomed the testing process: “We need to sort of tread carefully on it, and we’ll do that by doing some trials and almost doing some sort of experiments to see what works and what doesn’t and how technology can best be used to help encourage or nudge the self-employed into saving.”

Earnings limit improves adequacy

Adequacy has long been one of the major criticisms of the otherwise positively viewed auto-enrolment policy.

However, further increases to contributions will only be looked at once those already planned – bringing combined contributions to 8 per cent – have been implemented in 2019.

But the review does say pension saving should start from the first pound earned. This would bring an extra £2.6bn into pension saving, the DWP said.

For 2017-18, the lower earnings limit is £5,876, in line with the national insurance lower earnings limit. The upper limit of earnings for auto-enrolment is set at £45,000.

Making earnings pensionable from the first pound would mean those on low salaries in particular would see a larger proportion of their earnings go towards pensions, and also receive more employer contributions and tax relief.

Chris Curry, director of the Pensions Policy Institute and a member of the advisory group who led the review, said the aim of removing the earnings band is to ensure “that auto-enrolment contributions are actually 8 per cent rather than 8 per cent of a band of earnings that can fluctuate from year to year”.

He added that for those eligible to opt in, the move could make saving more attractive: “By having a contribution starting from the first pound there is more value for individuals for opting in.”

Multiple jobs problem remains

The review also recommends that the salary trigger for being auto-enrolled should stay at £10,000.

In the past, there has been debate about auto-enrolling multiple jobholders who do not qualify because they earn less than £10,000 in each job they hold.

Keeping the salary trigger unchanged means this group will still not profit from auto-enrolment, despite the DWP saying the government is committed to supporting people in multiple part-time jobs, who are predominantly women.

The advisory group has looked in detail at other solutions, such as aggregating across jobs, but dismissed these as unworkable. “Administratively there isn’t a simple solution that would enable that to happen,” said Curry.

“By removing the lower earnings limit for the contributions, actually if they do decide to opt in they get more benefit from doing so… it tips the balance in favour of being in a pension rather than being outside of it,” he added.

Contributions increase by stealth

The removal of the earnings limit will be a contributions increase by stealth. David Robbins, senior consultant at Willis Towers Watson, calculated that removing the lower earnings limit would have the same effect on a full-time employee on the National Living Wage as raising contributions to 12.8 per cent from 8 per cent under the current earnings limits.

The impact on take-home pay would be £235 for basic rate taxpayers where contributions are not paid by salary sacrifice, Robbins said.  

He warned of a possible negative effect on wages: “It is likely that the cost of higher employer contributions will feed through to wage growth – though the government will hope that this might be more robust by the mid-2020s.”

Robbins also pointed out that some large employers already pay contributions from the first pound in respect of basic salary, but not on overtime, commission or bonuses.

“There will be knock-on implications for them. The government will have to change the quality tests they use to ensure that contributions remain as good or better than the statutory minimum for at least 90 per cent of people. That could well mean increasing the headline contribution rates used for these tests,” he said.