25 February 2019

April 2019 contribution rises ‘will not lead to large-scale pension opt-outs’

5 min read

 
Steve Webb - Director of Policy

Steve Webb

Director of Policy, Royal London

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New research by mutual insurer Royal London has found that the next step up in pension contributions which takes place in April 2019 is highly unlikely to lead large numbers of people to give up on saving in a workplace pension.   

Royal London’s new policy paper – ‘What will be the impact of the April 2019 step-up in automatic enrolment contribution rates?’ – concludes that despite the hike in employee contribution rates from 3% to 5%, the impact on pension scheme membership will be minimal, as increased contributions will be partly or fully offset for most people by pay rises and a more generous income tax system. This view is reinforced by analysis in the paper of the behavioural response to the first step up of auto enrolment contributions in April 2018, when mandatory contributions rose from 1% to 3%.

a) What happened in April 2018?

The impact of the April 2018 changes can be measured in two ways – the proportion of people already in pensions who simply gave up as a result of the contribution rise (‘cessation rates’) and the proportion of newly enrolled people after April 2018 who opt straight back out again (‘opt out rates’). Both measures showed little change last year. For example:

• In the period April -June 2018, DWP figures show that the percentage of newly enrolled workers who actively opted out of pension saving (rather than simply changing job etc) was less than 6%; this was actually lower than in the previous quarter;
• There was a small increase in the percentage of workers who ceased pension saving in the April-June 2018 quarter, but this increase occurred exclusively in higher income groups; this suggests that this was more to do with factors such as limits on pension tax relief for high earners rather than the rise in contributions under automatic enrolment;
• Industry estimates also suggest very little impact from the April 2018 changes:
o The three largest master trusts found that opt-out rates were unchanged in the second quarter of 2018 at around 6.2%; cessation rates rose only slightly from 3.3% to 3.5%;
o Royal London found that the opt out rate for automatic enrolment schemes rose by just 0.4% between the first quarter of 2018 and the second quarter of 2018; at 7% this was actually slightly below the 8% average for the whole of calendar 2017.

b) What else will be happening in April 2019?

The new paper points out that changes in pension contribution rates are not happening in isolation. April 2019 will see an above-inflation increase in the personal allowance for income tax and an above-inflation increase in the national living wage which benefits millions of lower paid workers. These factors, together with annual pay rises, are expected to cushion the impact of contribution increases, leaving many workers with a post-tax pay rise in April, despite the contribution increase.

Table 1 shows an illustrative worker on £20,000 per year in 2018/19, who gets a pay rise in April 2019 in line with the growth in average earnings (3.2%) and pays 5% of their whole pay into a pension rather than 3% this year.

Table 1

 

2017/18

2018/19

Gross pay

£20,000

£20,640

Minus income tax

-£1630

-£1628

Minus National Insurance

-£1389

-£1441

Minus pension[1]

-£480

-£826

Net Pay

£16,501

£16,745

[1] We are assuming for this example that pension tax relief is delivered through the ‘relief at source’ method.  In this approach, pension contributions are made out of take-home pay and then HMRC tops up the pension with tax relief at the basic rate.  The worker therefore pays 4% of pay out of his/her take-home pay and this is grossed up to 5% by HMRC.Even though the pension contribution rate has increased from 3% gross (2.4% net of tax relief) to 5% gross (4% net of tax relief), the worker here still gets an increase in take-home pay in April of £244 per year or around 1.5%. Although this is below the rate of inflation and will represent a squeeze on living standards, the fact that pay is still going up, combined with the power of inertia, is likely to mean that few people will respond by pulling out of pension saving. In addition, this example assumes that the worker is paying 5% gross of his/her total pay. The legal minimum however is to pay contributions only on a band of ‘qualifying earnings’ above a floor of £6,032. This will further reduce the cash impact of the contribution rise for many workers.

Commenting, Steve Webb, Director of Policy at Royal London, said:

“The figures suggest good reason to be optimistic about the impact of the next step-up in contributions. A very timely increase in the tax-free personal allowance, plus a large rise in the national living wage will all help to boost paypackets in April. For a typical worker who gets an average pay rise, we find that their take-home pay will still go up in April, even allowing for the increased pension contributions. The bigger challenge is likely to be getting those 8% total contributions up to more realistic levels in future.”

Notes to Editors

The full paper: ‘What will be the impact of the April 2019 step-up in automatic enrolment contribution rates?’ is available on request and will be published at www.royallondon.com/policy-papers 

About Royal London:

Royal London is the largest mutual life, pensions and investment company in the UK, with funds under management of £117 billion, 8.8 million policies in force and 3,745 employees. Figures quoted are as at 30 June 2018.

For further information please contact:

Steve Webb, Director of Policy, Royal London