Millions face insufficient retirement income

The Institute for Fiscal Studies (IFS) reports that roughly 15 million people of working age are unlikely to achieve a sufficient retirement income, according to figures from the Department for Work and Pensions. The established second Pensions Commission aims to tackle this problem and plans to release policy advice next year, with an anticipated focus on reforming automatic enrolment.

The IFS suggests that raising minimum auto-enrolment contribution rates requires a more detailed approach and cannot be a single solution for all. There is widespread support within the pensions industry and among policymakers for increasing minimum pension contributions, but there is much less agreement about exactly how this should be done.

Changes to Qualifying Earnings Bands

A key choice is the ‘qualifying earnings band’, which currently calculates minimum contributions as a share of earnings between lower and upper limits (£6,240 and £50,270). Removing the lower limit completely and calculating contributions from the first pound of earnings could increase pension saving.

However, this change would have proportionately larger effects for low earners, who currently contribute a smaller share of their gross salary into pensions. Removing the lower limit, while keeping 8% as the total contribution rate, would increase the amount saved among everyone making minimum contributions by about £500 per year.

This translates to more pension saving and thus higher retirement incomes, but recent IFS analysis shows that the effects on take-home pay are also significant, and more so for low earners. Assuming a minimum total contribution rate of 12%, with a minimum employer contribution of 6%, lower earners would see a 0.3% fall in take-home pay due to higher employee contributions.

Impact on Low Earners

If contributions are calculated from the first pound, pension saving across those making minimum contributions would be another £750 per year more, and the fall in take-home pay for low earners would be much higher, at 1.7% of take-home pay. In reality, the fall in take-home pay is likely to be even larger, as economic theory and empirical evidence suggest that the costs of higher employer pension contributions will largely be passed on to employees through slower wage growth over time.

Taking this into account, a 12% minimum contribution calculated on qualifying earnings would reduce low earners’ take-home pay by 1.2%, or 4% if contributions were calculated from the first pound of earnings. This is significant, especially as around 23% of working-age people in working households currently have net household incomes after housing costs that are below the Pensions UK minimum Retirement Living Standard.

For the people most affected by these changes, the impact on their financial resilience could be substantial. Saving more into a pension pot now could severely impact people’s ability to make ends meet, particularly for those already living on low incomes. As the Pensions Commission makes its judgement, it is essential to consider the details of the proposals and how they will affect different groups of workers.