UK - Watson Wyatt has warned workers auto-enrolled into occupational schemes after 2012 could have an “exaggerated impression” of the size of their pension as typical minimum contribution rates into qualifying pension schemes will never be more than 6.8% of gross earnings.

The consulting firm claimed statistics provided by Rosie Winterton, the pensions minister, in Parliament earlier this week showed the use of banded or ‘qualifying earnings’ when calculating the minimum contributions of 8% - 4% from the employee, 3% from the employer and 1% in tax relief - would result in people saving less than they think.

In answer to a written question by Chris Grayling, shadow secretary of state for work and pensions for the opposition Conservative Party, Winterton stated in 2007 the median annual wage of workers eligible for auto-enrolment was £17,000 (€19,101).

Figures also showed 19% earned less than £10,000, while a further 43% earned a salary of between £10,000 and £20,000, resulting in over three-fifths of eligible workers earnings below £20,000.

Under the recent pension reform legislation, employers will be required to auto-enrol all workers over the age of 22 and earning over £5,035 a year into a ‘qualifying’ pension scheme, which would include personal accounts.

The requirement provides for the minimum contribution rate of 8% of “qualifying earnings” - based on an income of between £5,035 and £33,540 in 2006/07 earnings - to be phased in gradually, but Watson Wyatt said the 8% minimum “will never be more than 6.8% of gross earnings” as a large proportion of the targeted workers are on low incomes.

It pointed out, for example, the 19% earning less than £10,000 up to half of their income could be ignored when calculating contributions, and with the median income reaching just £17,000, Watson Wyatt concluded for around half of the workers auto-enrolled 8% of ‘qualifying earnings’ will actually equate to 5.6% of gross earnings or less.

In addition, the consulting firm claimed for one in five auto-enrolees the 8% minimum equates to less than 4% of gross earnings, and for around half of workers enrolled in a scheme after 2012 the 3% minimum employer contribution “will be 2.1% of gross earnings or less”.

Paul Macro, a senior consultant at Watson Wyatt, warned: “The way the system has been designed makes it important not to exaggerate how much money will be going into people’s pensions. It is dangerous to slip into a shorthand way of speaking and say that 8% will be paid into employees’ pensions. The real question is: 8% of what? Typically, the minimum contribution rates amount to less than 6% of pre-tax earnings.”

He pointed out with the majority of the target group for the pension reforms on low incomes the government should “make life easy for employers” wanting to maintain existing defined contribution (DC) schemes which use basic pay to calculate contributions.

For example, Watson Wyatt said for a worker on £17,000 a year a 3% employer contribution would be valued at £510 based on their whole salary but only £359 when using banded earnings.

The department of work and pensions (DWP) announced plans in November to allow employers to ‘self-certify’ their scheme meets the minimum level of contribution - allowing members and insurers to continue with the basic pay approach - and stated they would not be required to make retrospective reconciliation payments if contributions fall short unexpectedly unless “detriment” to the member exceeds a minimum threshold. (See earlier IPE article: Pension self-certifying may increase admin burden)

But Macro warned: “If people think 8% of their whole salary is being saved, they will have an exaggerated impression of how much is being put aside for their retirement. The great thing about DC pensions is that it is very easy to see how much cash is going into your account. People should be encouraged to look at these figures in relation to their total incomes and think whether they can afford to save more.”

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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