The Institute for Fiscal Studies has called into question the wisdom of many poor earners paying into workplace pensions under auto-enrolment.
It is not clear why the small number of people who would probably be better off not sticking with the default, and instead opting out of pension saving (at least temporarily), do not do so.
The IFS put forward various hypothesis’ – poor earners don’t know about the opt out, don’t know how to opt-out or can’t be bothered for the extra pay-roll cash it would bring.
The average gross earnings among the least financially secure group in 2018–19 were £357 per week, so ceasing pension contributions at 5% of their gross qualifying earnings (equivalent on average to over 3% of total earnings) would on average raise take-home pay by around £12 per week.
The numbers get worse for savers in net-pay schemes
That £12 per week figure is problematic. If the IFS’ poor-earners were in NEST it would be £12 but the Low Income Tax Group reckon it would be around £1.20 a week more if the low-earner saved with NOW or one of the other occupational pension schemes that don’t get low earners automatic tax relief (relief at source).
The IFS’ study should point out that for low-earners, the economic argument for opting out of a net-pay pension is up to 25% stronger than for opting out of a relief at source scheme.
Actually the real poverty tax is that those contributing to a net- pay scheme when earning below the minimum tax threshold could be paying a quarter more than those paying into a relief at source scheme, and they have absolutely no idea this is going on.
The graph has it
As you can see from the graph participation rates in auto-enrolment have increased even since the increases in contribution as the introductory taper wound out.
This is because of the steady inclusion of small employers at the end of the staging cycle and the consistency of opt-out which haven’t increased as contributions have been hiked. When Marks & Spencers first introduced AE – it required an employee contribution rate of 5% and this was thought to exclude many low-earners who would have opted out. The opt-out didn’t happen and M&S got an embarrassingly high bill for casual staff who they thought they’d not need to pension .
I think the same mistake may have been made in the Treasury. How else can we explain their failure to act on the “net-pay anomaly” when they had the chance (eg pre pandemic)?
What the IFS are pointing to as Auto-Enrolment , not as a policy success but as a policy failure (and its argument is reinforced by the net pay anomaly). This is the headline from a second IFS paper “who leaves their pension early after being auto-enrolled”
Pension participation amongst the least financially secure 3% of the eligible workforce is still 90%, up from just 22% before automatic enrolment
It is likely that there are significant numbers in this group who would be better off leaving their pension, at least temporarily, to have higher disposable income. Practically all of these employees have less than £1,500 in liquid savings, and could potentially benefit from a ‘rainy day’ fund.
So what is the counter-argument – why include the poor?
I am not going to fight fire with fire, on economic grounds Paul Johnson and the IFS are right, the lowest earners are probably better off putting better food on the table and avoiding debt than becoming sufficient in retirement. They are probably paying a poverty tax and being gulled into providing for themselves when they could rely on others in later years. I wrote back in 2017 that auto-enrolment could easily become a stealth-tax on the financially vulnerable and this worry has re-emerged
Frank Field would undoubtedly point to the dignity of those who labour and want to pay their way – at whatever price. There has always been an aversion for means-tested benefits and Field’s lifelong campaign to ensure that everyone was rid of them has a legacy in auto-enrolment.
But I don’t think you can establish a policy on the romantic notion of the dignity of labour. There has to be a bigger picture which allows those who are enrolling millions of poor earners to feel they do so for good.
I have been staring at this screen for a considerable amount of time, trying to come up with that argument and I cannot. Someone will need to explain to me the long-term benefit of millions of excess-pots being managed into retirement income by people with no access to affordable advice .
For me to be able to put up a reasonable argument for the exclusion of the poor from auto-enrolment , I am going to have to argue that there is a pension product for the poor which relieves poverty in retirement by increasing retirement income. I do not see one.
Who do the IFS say shouldn’t be in workplace pensions?
The IFS have constructed an index of the types of people saving into workplace pensions. At the top of the index are the people for whom AE is excess savings and at the bottom those for whom AE is a tax driving them further into poverty.
- 1st:most ‘financially secure’: meet the ‘financial security’ condition and have none of the ‘financial difficulties’ (22% of the 2018–19 AE sample);
- 2nd: do not meet ‘financial security’ condition, but have none of the ‘financial difficulties’ (38% of the 2018–19 AE sample);
- 3rd: have one ‘financial difficulty’ (29% of the 2018–19 AE sample);
- 4th: have two ‘financial difficulties’ (9% of the 2018–19 AE sample);
- least ‘financially secure’: have at least three ‘financial difficulties’ (3% of the 2018–19 AE sample).
You will notice that figure of 3% they quoted earlier.
Hit and hope?
So far auto-enrolment has worked on the principle of “hit and hope”. Hit millions with a pension tax which they don’t have to pay and hope that something turns up in the future which solves the societal problems of people living longer and dying expensively.
So far the one initiative that is working is the triple lock , paid for by pushing back the state retirement age.
But nothing has been done to address the question “how do people spend the money they have saved”. We are hoping that something will come up – some vaccine. But whereas a health vaccine makes the front pages, a means of improving people’s pensions from their retirement savings most definitely hasn’t.
Mel Charles, the new AE Director at tPR, should not let the Government rest on its laurels. The pressure on family incomes from the impact of pandemic should increase opt-outs, not just because people need rainy day savings but because auto-enrolment saving is not saving for a pension , but saving for a different rainy day.
To really bed down auto-enrolment and make pension savings more than hit and hope, we need strategy to turn pension pots into retirement plans. We may have one , for the mass affluent, but for the people in the bottom tiers of the IFS’ “financial security index, I am on the IFS’s side .
Unless we can get people saving for a decent retirement income when they want their money back, auto-enrolment will have failed. People need to be able to swap cash for proper pensions and those proper pensions – for low earners at least – need to be collective.
The argument for enrolling low-earners must be made by demonstrating the future benefit and we are ill-equipped to do that right now.
There is a particular issue for those who will be on means tested benefits in retirement and will be renting their homes. Pension money taken after retirement can significantly scale back those benefits and negate the value of saving for a pension.
However, I think there is a strategy that could work for many over the age of 55. They could accept auto-enrolment and regularly take money out of a DC pension scheme using UFPLS. Their employer’s contribution is likely to exceed the tax they pay on money taken. They will trigger MPAA, but that is unlikely to be a practical concern for those on low pay.