The DWP’s paper on low earners and pensions is a qualitative paper. That means it deals with everything but the maths. Yesterday I argued that for low earners, pension saving may not always be the right thing to do. Today I put my very ill-fitting maths hat on and with the help of the Ferret- Gareth Morgan show how in certain cases, the financial case for contributions is so compelling that you can get almost 90% of your contribution paid for you by your employer, the HMRC and the DWP – through universal credit.

Some of my calculations may sit awkwardly against universal credit thresholds (see diagram below) , but the principal is good and I’d be happy to have my calculations challenged by Gareth or the Low income Tax Reform Group (LITR).

There is a lot going on for people on low incomes when it comes to making pension contributions and I suspect that very little of it is considered by pension companies or advisers, for whom the low-earner is not a high priority customer

The difference made by being on  universal credit

If you are on universal credit and pay into a net pay scheme , you could get 86% off your pension contributions by not opting out or opting into a workplace pension.

Yesterday I wrote

” I have mentioned the problems low earners have with cashflow (especially with net pay) and with means tested retirement benefits.”.

Gareth Morgan , doyen of the unexpected consequences of integrating pensions and benefits replied.

Don’t forget, for some, the good news for working age in-work benefits..

The Universal Credit’s means test disregards pension contributions as income in the assessment.

This means, for low earners on Universal Credit,  every £1 of pension contribution reduces your income that’s used in the means test by £1. The effect of that is to increase benefit in the next month by 55p in hard cash.

So, pay in £50 a month and it actually costs you £22.50. That’s a pretty attractive deal if you can afford it.

Conversely, if you need to opt out because you could do with the extra £50 and you’ll only get £22.50 as an increase in income.

That’s not widely understood, either by individuals or by the industry which, I’ve always thought should use it as a marketing approach.

We may stop to wonder at this information. If it only costs you £22.50 to pay £50 into your pension , then you are getting 55% off

We can go further, if the individual is in a Relief At Source scheme, £10 of that £50 contribution is paid  by the taxman, even if the payer is not paying tax,  here the calculation is that your benefit has increased by 40 x..55 =£22 but you’ve got £10 extra in your pension so your £40 has got you £50 into your pension at a cost to you of  £18., that’s 64% off.

Now let’s think of what happens when someone on net pay and getting universal credit gets a payment from the taxman in 2025 of £10 (20% of the £50 they paid in the previous tax year) . They find themselves (eventually) £10 better off for making the £50 payment that cost them £22.50 the previous year, that’s only £12.50 to get £50 into your pension, that’s a stonking 75% off your pension contribution, – albeit some of the gratification is deferred,

You may ask me what the implication on universal credit will be of the £10 paid next year and that I do not know. But I think it harsh of HMRC to treat what is effectively a savings incentive as income for the purposes of universal credit.

There is another set of calculations for the self-employed which are even more complex because the self-e- that is for another day.

Right now, let us consider this as Martin Lewis might. If you are a low earner claiming universal credit , you can get 64% off your contributions today if you are in a net pay scheme and you can get 55% off today and a further 20% off next year, if you are in a net pay scheme.

This makes opting into auto-enrolment for those earning less than £10,000, a financial opportunity – so long as you can afford to pay between  25p to get 100p in, (net pay) or 32p to get 100p in (relief at source). Some UC claimants will also be entitled to employer contributions on top, which will make participation in workplace pension saving even more attractive (see entitled v eligible below).

Although there are savings limits for claiming UC, pension savings do not form part of them. So long term money is better in a pension than in a savings account

Universal credit savings limits

Employer contributions take over from universal credit as you earn more…

As you earn more, universal credit falls away to a point where you can’t get claim it  any more (see below), But this is compensated for by you being eligible for employer contributions either on an opt in or opt out basis

Providing you earn more than the lower earnings threshold of £6,240 pa.  you are “eligible” for an employer contribution of 3% of your earnings above £6,240 pa. This is absolutely free money. So for the person who pays £50 into a workplace pension as an eligible jobholder or an opting in non-eligible job holder then the 3% is on 25 x the £50 (which is 4% of earnings) – another £37.50.

So now the relief at source contributor  paying £40 gets a £50+37.50 =£87.50 pension contribution, still 55% off

The person on net pay is now getting tax relief through the PAYE system and is on the same deal as the relief at source customer (Paying £50 , getting £10 more in pay and getting £37.50 from the employer) Again  more than half of the contribution is being paid by other people.

Entitled v Eligible

The “entitled” worker- earns to little to be eligible for employer contributions  but gets the benefit of UC when opting into a workplace pension  (as he/she is “entitled” to do)

People who earn less than £6,240  are  only “entitled”  to join a workplace pension – who are most subsidised when making contributions . They may not get an employer contribution but they get full Universal Credit. It may sound awkward, but the small amounts a really low earner pays into a workplace pension (through payroll) are the most subsidised

If you earn less than £6,240, you still qualify for between 64% (relief at source) and 75% (net pay -£55+20%), But my calculations show that as you move into higher paid work (with the floor of a minimum wage) , the benefits of employer contributions continue to make auto-enrolment financially worthwhile, even as UC drops away.

The financial argument is not the only argument and workplace saving may be a bad idea in other respects but my research (helped at every step by Gareth and LITR) suggests that the current system of triggers and means testing is actually very fair.

Anyone earning under the £10,000 earnings threshold is going to have to figure this out for themselves and apply to get into a workplace pension. They are going to need to be pretty determined and have some cash to spare, but financially it is worth it.

There are no cliff-edges for the low paid, so long as the Government fulfils on its promise of compensating the non-tax-payer, for lost incentives when paying into pensions via net pay.

The earnings thresholds for NICs, UC and pension contributions are well designed for the low-earner and ,if properly understood, doing what UC , tax and NI triggers should do.

Getting the message out

I am sure that a lot of people entitled to join a workplace pension don’t join because they aren’t aware of the opt-in. We need to find ways to get low earners to want to join. Sadly this is not necessarily in pension company’s interests. Small pots – especially deferred small pots – are a menace to profitability, costing more to maintain than can be collected from fees.  Solving the small pots problem would encourage providers to promote savings for low-earners more than they do,

It may be that at some time in the future, the 2017 AE reforms are enacted and these low earners are auto-enrolled, but there are big issues here, political, social and fiscal. We need to work on the basis that the current rules are here for the foreseeable – no-one should be left behind.So for now, the opt-in is the best low-earners (those with earnings under £10,000 get).

Explaining all this comes down to convincing to those with low earnings , with some cash to spare and with a positive mindset towards saving, that workplace pensions can work for them.

The success of the Sidecar savings experiment at SUEZ suggests that many low earners are prepared to opt in or reverse an opt-out if matters are made plain to them. More people have the ability to save and want to save than participation rates

We need to get positive savings messages out through employers (SUEZ is a great example) and we need the support of master trust funders and GPP providers active in the workplace.

Finally, we need to ensure that MaPS and other government sources of information are making everyone aware that there are great advantages to saving. Getting 75p in the pound of your pension contribution paid for you, is a good start!

Erratum

Thanks to all my skilled and learned readers for suggestions on this article which is a work in progress. Richard Chilton’s comment has prompted a change from an earlier version)