Why isn’t 8% of my salary going into my pension like it’s meant to? STEVE WEBB replies

At my place of work, a big retail chain, the agreement for workplace pension contributions is 8 per cent, including 4 per cent from the employee.

I work in the warehouse as a warehouse operator (not management).

When I questioned HR on why 4 per cent of my wage was not being taken out, I was informed that there is a £480 (per 4 weeks) threshold and that the pension contributions start after this £480.

Whenever I read up on work place pension contributions, I see it stated about the minimum 8 per cent but in reality this is not correct, due to this threshold figure.

My questions are: why is 8 per cent given as a minimum, and why and when did the £480 threshold come into effect?

Steve Webb replies: The often-quoted figure of 8 per cent minimum workplace pension contributions is, as you rightly say, not quite what it seems.

I’m happy to explain what is going on, why it was set up in this way and how it might change in future.

To understand what is going on, it’s worth going back to basics about what pensions are trying to achieve.

One of the main reasons why we have a pension system is to help ensure that people’s standard of living does not drop sharply when they no longer have a wage.

To achieve this, we often talk about a target, for people on modest incomes, of securing around two thirds of pre-retirement income once you stop working.

People should not need 100 per cent of their pre-retirement income because they typically no longer have ‘working age’ costs such as mortgage, travel-to-work or childcare costs, and also no longer pay National Insurance on their income.

But a target of around two thirds would enable most people to enjoy a similar standard of living when retired to the standard they were used to when in work.

The next thing is to look at how much of this will come from the state pension.

As a very rough benchmark, the new state pension will replace a little under one third of the average worker’s wage.

This means that they need a similar amount from a private pension to bring them up to the two thirds target.

When automatic enrolment was being designed, it was assumed that the first slice of earnings was fully replaced by the state pension and that what was needed on top of this was a percentage of the ‘next slice’ of earnings.

For this reason, when the law was written to require workers and firms to make pension contributions at a set percentage rate, this percentage was applied to earnings above a floor, currently £6,240 per year.

Earnings above this level (up to a ceiling of £50,270) are described as ‘qualifying earnings’, and the mandatory 5 per cent from the employee (or 4 per cent net of tax relief) and 3 per cent from the employer are applied to this band.

I should stress that we are talking here about the legal minimum rates of contribution and that many employers and workers do more than this, including some who apply contributions from the first pound of earnings, not just on ‘qualifying’ earnings.

Over time there has been growing concern over this system, particularly because of the impact on lower earners.

To give an example, for someone who works part-time and earns (say) £12,480 – double the floor for qualifying earnings- the mandatory pension saving rate is applied to just half of their wage. By contrast someone working full time on £31,200 – five times the floor – is making contributions based on four fifths of their total wage.

In response to this, a Government review of automatic enrolment published back in 2017 recommended that the starting point for contributions should be reduced to zero, so that the 8 per cent headline figure would apply to all earnings up to the ceiling, currently £50,270.

Despite the general consensus about this recommendation, nothing has so far changed. In the last parliament a law was passed which paves the way for this change, but it has yet to be implemented.

Unfortunately, it seems that progress on this front is probably now further away than it has ever been.

The reason for this is that any widening of the band of ‘qualifying earnings’ would cost both workers and employers more.

With concerns over an ongoing ‘cost of living’ crisis for many lower paid workers, and with a very substantial increase in employer National Insurance in the Autumn 2024 Budget, there is very little appetite in Government for further measures that would hit paypackets or employer costs.

In short, therefore, although we urgently need to get more money going into pensions, the chances of reform any time soon look very small.

The one glimmer of hope is that the Government is expected shortly to announce the second phase of its major review of pensions, and this will include the adequacy of existing pension saving rates.

It is possible that such a review will eventually (again) recommend applying mandatory contributions to the first pound of earnings, not just those above a floor.

But, even if it did so, I suspect that the implementation process would be protracted and could even fall outside the current parliament.