Will workers jump or stay in the pension saucepan?

Ian King, Sky News Business Presenter
The theory of the frog and the saucepan is well known.

It holds that, if a frog is dropped into a saucepan of boiling water, it jumps out. However, if the frog is placed in a panful of tepid water that is slowly warmed up, the theory has it that the frog will not notice and is eventually cooked to death.
The financial equivalent of this experiment has been taking place since 2012, with millions of Britons participating as the frog. But next year the water starts to warm up. The outcome will provide clues as to whether one of the most important, ambitious and potentially far-reaching policies pushed through by the UK Government during the last decade is working.

Image: All employees over the age of 22 are automatically enrolled in the scheme
Five years ago the Coalition government, continuing work begun by the Blair and Brown governments, pressed the button on ‘auto enrolment’. This obliged every employer to set up a workplace pension scheme into which all employees over the age of 22, earning more than £10,000 annually and not already in such a scheme would be automatically enrolled – unless the worker specifically asked to opt out.
Under the scheme, a minimum 2% of a worker’s earnings are contributed: 1% from their employer, 0.8% from the employee and a further 0.2% in tax relief.
Thus far, the scheme is reckoned to have been a success, with some 800,000 employers having enrolled getting on for nine million people into a workplace pension. Fewer than one in 10 employees have opted out. The big test, though, comes next year.
From April, the minimum contribution rises to 5% of a worker’s earnings, with 2% coming from the employer, 2.4% coming from the employee and a further 0.6% in tax relief. Then, in April 2019, the minimum contribution rises to 8% of earnings, with the worker putting in 4%, the employer chipping in 3% and tax relief a further 1%.

Image: Will employees notice when their take-home pay falls?
And this is where the frog and the saucepan analogy comes in. Question one is whether employees notice that their take-home pay is falling gradually as a result of their pension contributions rising.
The chances are that they will.
Take, for example, a 30-year old woman earning the average annual salary of £27,000. At present, she is paying £22.50 per month into her workplace pension, which includes £4.50 of tax relief. When the contribution rate rises next April, that will rise to £67.50 per month, of which £13.50 of tax relief is included. And when the rate rises again in April 2019, her contribution will increase to £112.50 per month, of which £22.50 is tax relief.

In other words, in the absence of any pay rise, the woman will be taking home £36 a month less next April than she was the month before. And in April 2019, her take-home pay will fall by a further £36 a month. It is impossible to think that this will not be noticed – although the increases in the personal allowance (the sum a worker may earn before paying income tax) by Chancellor Philip Hammond in last month’s Budget will mitigate that to an extent.

One good reason for workers to stay in the scheme is the tax relief still available on pension contributions. It currently allows workers to shelter £40,000 a year from the taxman.
Ian King, Business Presenter

Question two is whether, akin to a frog jumping out of the saucepan as the water heats up, workers start to opt out of their workplace pension schemes when they notice their take-home pay is falling.
The Government will hope they do not. The whole point of auto enrolment was to ‘nudge’ lower paid workers into making some kind of provision for their retirement. The biggest single cause of pensioner poverty is a lack of any retirement savings other than the state pension and auto enrolment, a policy conceived by Labour and implemented by the Conservatives and Liberal Democrats, was an attempt to tackle it.
Efforts have been made to calculate the extent to which increasing numbers of employees will opt out of their workplace pension scheme. The life insurance and fund management firm Royal London, which currently administers more than 5,000 workplace schemes, has noted that opt-out rates under the current arrangements are lowest among the under-30s, at around 7% of the workforce, but highest among workers aged 50 and over – one in four of whom have been opting out. That may be because older workers already have other retirement savings in place.

Image: A quarter of workers aged 50 and over have opted out of the scheme
It is the reaction of younger workers that will be crucial. Workers aged between 22 and 29 have signed up under auto-enrolment in greater numbers than any other age group, which is encouraging, although the insurer Aegon recently reported that two in five millennials still have no pension provision in place.
Employers and the Government need to be banging the drum a lot harder to promote the benefits of workplace pensions in the run-up to the contributions rising next year.
There are many good reasons why employees should remain in their schemes. The greatest of these is that, so long as they do, their employer will be contributing to their pension. Another is the tax relief still available on pension contributions, which currently allows workers – other than top-rate taxpayers – to shelter £40,000 a year from the taxman. The third, of course, is the reduced the risk of being impoverished in retirement.