The publication of the DWP’s flat rate pension proposals are meant to help auto-enrolment, not damage it. They are supposed to provide a solid bedrock upon which savings can be made, with the aim of giving the millions of currently unpensioned Britons a decent retirement. But low earners with full work records will be actually worse off as a result of the combined effects of the state pension reforms and auto-enrolment. What they gain from auto-enrolment will be more than wiped out by the state pension they stand to lose. This cannot be what was intended.
The DWP bill published last week has created big winners and big losers. Unfortunately for those involved in auto-enrolment, many in the target market for this great experiment in DC will never claw back through their personal plans the income they will lose in the state pension shake up.
The government has done a lot for those with short contribution records, including a large number of women. And anyone in a defined benefit scheme is doing very well out of the reforms as they will in future able to buy state pension above the basic level at a very reasonable cost. The self-employed are also big winners, as are those who contracted out of state second pension into a personal pension, as they get to keep this pot and get the chance to rebuild state pension to the same level as those who stayed in.
Contracted-in high earners are the biggest losers in income terms. But the biggest group of losers numerically looks like being low and medium earners with long work records and no other pension provision – precisely the target market for auto-enrolment. Those over 40 are particularly badly hit.
What is missing from the DWP’s white paper is clarity about just who loses from the abolition of state second pension. In fact you will struggle to find anywhere on the web an accurate calculation of how to work out how much state second pension you will get.
As explained in our news pages in recent days, a low earner on £14,200 with a full work history would have expected a state second pension of £2,444 a year if retiring in 2025, £2,860 a year retiring in 2035 and £3,380 a year in 2050. Factoring in basic state pension gives combined state pension of £8,031.40, £8,447.40 and £8,967.40 for these three cohorts of low-paid workers – all of which are higher than the £7,488 a year flat rate pension. Medium earners on £25,800 lose nearer £2,000 a year from the changes.
The Pensions Policy Institute will tell you that the transition to flat rate pension in the White Paper is considerably more generous to those who are contracted out than it was in the Green Paper. The government’s thinking here is to make sure more people get the full pension more quickly.
Chris Curry, policy director at the PPI tells me that by 2050 under the old scheme only half of people would have been receiving the full flat rate pension, as many would have still been getting part of their pension from income from contracting out. It appears the government thought this would have been too much for people to understand. Because the White Paper allows those who have contracted out to rebuild their state pension more quickly, by 2030 about three quarters of people will be getting the full pension.
So the changes that penalise those not contracted-out are being done for the sake of simplicity. Everyone likes simplicity, but the bad news for the auto-enrolment target market is they are largely the ones bearing this cost, which is ironic given the system is being sorted out to help them. Anyone who is contracted out can build up state pension from the basic level at £4.11 per year of contribution, meaning 10 years of contributions will put them back on the same state pension as a contracted-in person whose accumulation was frozen at £144 or less. But they also get their contracted out benefits as well. This has the perverse result of penalising those without pensions at the cost of those with pensions – because those who have contracted out have, by definition, got a pension.
The White Paper suggests that those who lose out from the abolition of state second pension will see that loss offset by their auto-enrolment pension income. But a look at the figures suggests this rosy perspective is flawed.
A low earner hitting state retirement age in 2025 enrolled into a scheme paying a combined employer and employee contribution of 8 per cent of band earnings can expect to build up a pension income of £520, according to mainstream pension calculators, which is less than the £543.40 state pension they will have lost.
A low earner reaching state retirement age in 2035 automatically enrolled on the same basis can expect to build up an income of £1,085.19, which is £125.79 a year more than the £959.40 lost state pension, although the worker will have saved and contributed for 22 years to achieve this.
A medium earner hitting state retirement age in 2025 enrolled into a similar scheme today can expect to build a retirement income of £1,219.67, meaning his or her income is £779.73 worse off in retirement, having contributed into a pension for 12 years.
A medium earner on £25,800 hitting state retirement age in 2035 can expect to build up auto-enrolment pension income of £2,543, leaving an income £595.60 a year or £11.45 a week higher after 22 years contributing into a pension. Whether we will see lobbying for a change to this position remains to be seen. If not, a review of total pension coverage in the auto-enrolment target market in 20 years’ time is going to show some pretty surprising outcomes.