From the TUC

Why pensions auto-enrolment should not hold back the minimum wage

17 Jan 2012, by in Pensions & Investment

Business organisations are arguing that the introduction of pensions auto-enrolment later this year is an argument for holding down the minimum wage. At first sight they might have a point.

Pensions auto-enrolment for the first time will force employers to contribute to the pensions of their staff. This is absolutely right, but unlike some employer complaints it is undoubtedly a burden on business as pensions contributions have a price tag. No doubt for staff higher up the income scale employers will attempt to recoup some of the costs from their wages, but as you cannot cut the minimum wage this is harder for those who on the legal minimum (though there may be some pressure on hours).

But closer examination of the figures suggests that the cost of auto-enrolment, particularly for the next few years, will be tiny for minimum wage workers.

How auto-enrolment works

First, let’s remind ourselves of the detail of auto-enrolment. Auto-enrolment starts in September. Employers have to choose a suitable pension scheme for their staff. They must auto-enrol all staff over 22 who earn above a threshold into this scheme within three months of starting a job. (This House of Commons Library note is a great detailed resource).

Unless the worker opts out, the employer and employee must both pay contributions into the scheme. The minimum is set as a proportion of a band of earnings. The employer pays 3% and the employee pays 4% of this band. (In addition the state contributes one per cent tax relief.)

The earnings band figures were set in 2006 at £5,035 and £33,540, but need to be uprated. The government is currently consulting on what the band should be when auto-enrolment starts later this year.

Originally the lower earnings band was also the threshold for auto-enrolment. As soon as someone’s pay rose above £5,035 contributions would need to be paid on their  wages above this. figure.

The new government set up a review into auto-enrolment. Ministers accepted its recommendation that an auto-enrolment threshold should be set at £7,475.  This means that people will only be auto-enrolled once their pay goes above this (the income tax threshold).

There is still an earnings band, and employers and employees still have to make contributions on pay within this band. But below the earnings threshold workers have to opt-in. Above the threshold they are auto-enrolled and stay as scheme members even if their pay subsequently falls below the earnings threshold.

We were not very keen on this. While it does stop people earning just above the lower earnings band making tiny contributions, it introduces a ‘cliff-edge’. When  someone’s pay rises above the threshold, they become liable for contributions on what is likely to be around £2,100 of earnings once the bands have been uprated.

Staging and phasing

Introduction of auto-enrolment is being both staged and phased.

Staging brings different employers into the regime at different times. The biggest have to start auto-enrolment in October 2012. The smallest do not have to begin until after the 2015 election. (Employer size is measured by PAYE scheme size.) The government delayed the final phase for  small businesses for a year in the Autumn Statement. The precise timetable is about to be published.

Phasing means that employer contributions start at one per cent and are then increased in two phases to 3%.

Employers pay just 1% until September 2016. Employers then pay 2% until September 2017. They only start to pay the maximum in October 2017. While the delay was sold as a help to small firms, it has also delayed the second and third phases for all workers. This means that those auto-enrolled this year will be stuck on 1% minimum contributions for four years (although many employers are intending to be more generous than the minimum.)

Minimum wage workers and auto-enrolment  

There are a number of reasons why the impact on minimum wage workers and their employers is modest:

  1. DWP research suggests around one in three of low paid workers will opt-out. The earnings band studies goes above the minimum wage, and it is possible that opt-out rates will be higher for those on the lowest pay.
  2. Many minimum wage occupations are high churn. The three month waiting period (introduced by this government) will mean that employers do not have to pay contributions for the first three months of employment.
  3. The earnings band is very important in minimising the cost to employers. If the government uprates the lower earnings band by maintaining its link to the Natinal Insurance Lower Earnings Limit it will be set at £5,564.  At the current NMW of £6.08, this means that staff will only pay and get contributions for hours they work above 17.6 a week. Many NMW workers are part-time and may not get above the lower earnings band.
  4. The new auto-enrolment threshold means that they will need to work more than 23.6 hours before they are auto-enrolled. 70% of all part-time workers work less than 23 hours according to the ONS ASHE survey. Part-time minimum wage workers may have a different hours profile, but it’s not likely to vary a huge amount from that. (If anyone knows a source for these figures – let me know in the comments.)
  5. A full time worker (40 hours a week) on minimum wage earns £12,650 (with some rounding). Their employer will contribute one per cent of the difference between this and the earnings band. Until 2015 this will be one per cent of £7,086 or £71 a year or £1.36 a week. This represents an increase in the wage bill of 0.56%.
  6. Only employers employing more than 1,250 staff will start auto-enrolment before October 2013. Those employing fewer than 50 will not have to pay pension contributions until at least 2015.

It makes sense to think of auto-enrolment as the pensions analogue of the minimum wage. But it is not going to do a great deal to help minimum wage staff, particularly part-timers and particularly before the staging and phasing have finished.

This means the burden on minimum wage employers is minimal as much of the earnings of low-paid staff are not eligible for pension contributions. Many fall below the earnings band; many work for small companies that will not face auto-enrolment until after the next election in 2015; AND, contributions on earnings above the earnings band are restricted to 1% until 2016.

There is therefore no case for holding down the minimum wage due to auto-enrolment in discussions about setting the minimum wage for next year.

Indeed I would hope that most people reading this would see it as an argument for increasing pension contributions.