The pensions world awaits the detail of the government’s White Paper setting out how they will achieve their goal of providing a single flat rate pension set above means-testing level. It’s a worthy objective – and many of the right people will gain – but the test will be how it’s paid for.
But that analysis has to wait until we see and analyse the White Paper. What we can do now is look at the implications of a flat rate pension for other parts of the policy jigsaw as pensions policy in recent years has been set assuming that many people will retire and rely on means-tested pensioner benefits. Indeed this was a favourite starting point for those wishing to oppose auto-enrolment – inevitably some people will lose means-tested benefits to the extent that they might have been better off opting out, even if the numbers are likely to be quite small, particularly when compared to the millions who gain.
We can dismiss those who think potential savers sit down with an economics textbook to remind themselves how to rationally weigh up the deferred benefits of a pension less the possible impact of an unknowable future means-testing system, work out the appropriate discount rate and then conclude that they should opt-out. But the impact of means-testing does need to be a consideration for those of us interested in policies that promote saving. If there is to be no impact from means-tested pensioner benefits then it makes it easier to spread a universal message that pensions saving is a good idea.
Perhaps the biggest policy impact of likely means-testing has been the design of auto-enrolment contributions. We happily talk of eventual minimum contributions of eight percent, with three percent from the employer, four percent the employee and one percent tax relief. It is easy to forget that this applies only to a band of earnings – currently set between £5,564 and £42,475. In addition you need to earn more than £8,105 before you are auto-enrolled. If you earn above the lower band but below this trigger income you can still opt-in (and I’m sure your employer will be overjoyed.)
The graph shows the slightly odd auto-enrolment contributions profile this system produces. This models a full eight per cent contributions at current values for the earnings band and earnings trigger (although we are still in the phasing and staging phase with one per cent contributions from employee and employer).
This clearly shows that nobody gets eight per cent. The most anyone gets is just under seven per cent (6.9 in fact) and that is only the comparatively well off at the top of the earnings band. Most people earn significantly below this, and it would make sense – if you want shorthand – to talk about typically six per cent contributions under auto-enrolment.
The earnings band was introduced at least partly to stop the very low paid building up small contributions that would not make them much better off in retirement because they would lose out from means-testing. It was of course heart-warming to see such concern for the low paid from those who would otherwise have happily paid their employer contributions.
The earnings trigger came later – under this government – and was also at least partly designed to stop people building up pots they would then lose through interaction with means-tested benefits.
But if all pension savings in future will build up additional pension on top of a state pension already above means-testing levels, these arguments disappear.
Many people now accept that, while it won’t come overnight, we need to increase contributions. No doubt we can develop some smart ways of persuading some people to voluntarily save more, but the only way to make a substantial impact will be to increase minimum contributions. This will need to be phased, but it is not unreasonable to see the Australian level of nine per cent as a medium term objective.
The easy call would be to argue for higher percentage contributions. But there is a strong case for reducing the percentage contributions, as long as you impose them on a wider band of earnings. If we take the top of the band as a pivot point and fix the percentage contributions on total pay at 6.9 per cent we can move the lower earnings band towards zero until people start to get contributions from their first pound of earnings.
If we did this with one transitional stage we could move the lower earnings band to £3,000, (and have an earnings trigger of £4,000 purely to stop very small contributions adding to employer and pension scheme costs if that is desired). We would then set the contribution level at 7.4 per cent to ensure that those at the top of the earnings band continue to get 6.9 per cent of their total salary put in a pension. Everyone earning less than this would gain, and while those above would lose, in practice most people on such high earnings will not be relying on minimum auto-enrolment pensions.
In the next stage you could start pension contributions from the first pound of pay, maintain a £1,000 de minimis trigger and reduce contributions to 6.9 per cent.
Only after that would you start raising the contribution percentage level under this approach.
This graph shows how this would work, and how it would concentrate gains on the lower paid – in practice mostly women working part-time who have not been served well by recent changes – in the early stages. Only after these transitional stages do the better paid start to gain.
What about cash contributions? This chart shows total pension contribution required against pay. This shows that this is a very modest proposal (although it would impact employers with a large part-time workforce and not much else). It would not need lengthy staging – and indeed you could lower the earnings band with a smaller or even no reduction in the percentage contribution if the economy was in more robust health by the time we implement this. I’m not advocating any particular set of numbers or timetable in this post – simply hoping to start a debate and draw attention to the impact of the band.
This graph better shows the effect on those earning less than £30,000 – the majority of the workforce.