Automatic Enrolment (Earnings Trigger and Qualifying Earnings Band) Order 2012
(12 years, 7 months ago)
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Lord Freud
That the Grand Committee do report to the House that it has considered the Automatic Enrolment (Earnings Trigger and Qualifying Earnings Band) Order 2012.
Relevant documents: 44th Report from the Joint Committee on Statutory Instruments
The Parliamentary Under-Secretary of State, Department for Work and Pensions (Lord Freud)
My Lords, I am pleased to introduce this instrument, which was laid before the House on 26 March. I am satisfied that it is compatible with the European Convention on Human Rights.
The original qualifying earnings band was set out in the Pensions Act 2008. We amended the Act last year to insert the automatic enrolment earnings trigger but these figures are now up to six years old. It is essential to keep the automatic enrolment thresholds up to date and relevant.
The original figures are subject to a mandatory annual parliamentary review. This first review needs to catch up with six years’ worth of change. Our task is to consider the outcome of this year’s review—the revised rates that will apply when the largest companies start to implement automatic enrolment from July of this year. This is an important and much anticipated debate. I am glad to see that we have the benefit of having pensions experts and champions of automatic enrolment with us this afternoon. I have been grateful for their expertise in the past and I remain grateful now. I look forward to what I am sure will be a robust and thorough examination of these thresholds.
The power to revise the automatic enrolment threshold is a broad, flexible power. Flexibility is important. Rather than a lock-in to a set formula with a short shelf life, flexibility safeguards the interests of savers, employers and the public purse. Flexibility enables this and future Governments to react to the changing financial landscape, the number of people saving and the amount they are saving, all set against the backdrop of the shape of state pensions.
However, flexibility and the degree of discretion that Parliament has allowed makes the task of setting the automatic enrolment thresholds for private pension saving more challenging and perhaps more contentious than the state pensions uprating exercises that we are more familiar with. The amount of the automatic enrolment earnings trigger and the lower and upper limit of the qualifying earnings band are critical to deciding who should be auto-enrolled, when it makes sense to start saving and how much people should save. Targeting is critical. We must safeguard the interests of all workers who may be in scope for automatic enrolment including the lowest paid. If the trigger is too low the low paid may baulk at the costs and opt out.
Persistent low earners tend to find that state pensions provide them with an income in retirement similar to that in working life, without the need for additional saving. For these individuals, it will very often not be beneficial to direct income from working life into pension saving. If we are to meet the challenge of pension undersaving, we have to get the pension-saving message out into the workplace. We are about to see a revolution in workplace provision. We are asking employers, payroll providers and the pensions industry to take on significant additional responsibility.
Workers will need to understand how pension saving will work. They will need to know how automatic enrolment will affect them, when it will affect them and how much it will cost. We know people will see their employer as a first port of call. We have to make automatic enrolment simple for employers to understand, administer and explain. The automatic enrolment rates for this year need to balance complex interactions between targeting, simplicity, affordability, costs and savings, and take account of equality issues. The problem is that simplicity and pensions are not natural bedfellows. The Government felt that the best way forward was to have a full consultation on the proposals for the first year of live running. Up to now employers and the pensions industry have been working with figures that are unlikely to be the ones for live running. We wanted to share our thinking and the evidence we took into account as part of the review process.
We needed the views of employers who will have to make automatic enrolment work in practice; of the companies who will provide pension schemes; and of the representatives of people who will be brought into pension saving, possibly for the first time. The Government have now reviewed this evidence from the public consultation and weighed the costs, savings and low-earners issues carefully in arriving at the figures that I present to your Lordships today. Targeting is critical but the level of the trigger is a difficult judgment because everyone’s personal circumstances will differ and will change over their lifetime. When household finances are under pressure, we do not believe it is right to encourage low earners—whatever their gender—to save at a time when they may need to use all their income to meet their family’s present living costs.
We propose an automatic enrolment earnings trigger of £8,105, aligned with this year’s personal tax threshold. Tax relief is a core part of the automatic enrolment deal. We believe that automatic enrolment should target people once they earn enough to pay income tax and therefore qualify for tax relief, and should exclude the low paid who will have a high replacement rate from state pensions alone. This exclusion is from automatic enrolment, not from pension saving per se. People on low earnings in households with a higher earning partner may be in a position to put something into a pension. People on low earnings with an expectation of a rise may want to get a toehold on pension saving. That is why the right to opt in, with an employer contribution, is such an important feature of these reforms. Any rise in the trigger disproportionately affects women. I make it completely clear that we are not weighing equality against cost; gender is not the issue here. The outcome of this review is right for all people on very low incomes, regardless of gender.
The results of the consultation were powerful and persuasive. Simplicity is critical to the success of automatic enrolment. It is best supported by aligning the automatic enrolment thresholds with existing payroll thresholds to give employers and individuals figures that they are familiar with and can explain.
I turn now to the qualifying earnings band. The headline message from the public consultation was that the band should maximise pension saving. This suggested that the right direction was to set the lower limit fairly low—and nor should we set the cap so high that it significantly increased employers’ minimum costs.
I am acutely aware that your Lordships’ views were mixed about the point at which we should pitch the lower limit of the qualifying earnings band. There was some residual support for not having an earnings band at all. The previous Administration ruled this out on the grounds of cost, and we continue to do so.
There is a good case to be made that pensions saving should rise as earnings rise, and that the original thresholds in the Pensions Act 2008 should be revalued by the rise in average earnings. That proposition was put in place by the previous Administration. There is also a logical argument that the automatic enrolment thresholds that will drive minimum pension saving levels should rise in line with the consumer prices index, for consistency with the Government’s wider policy. Price inflation affects affordability. It has a very direct bearing on how much people can afford to pay into their pension, and a direct bearing on employer costs. However, neither price nor earnings inflation produces a figure that aligns with existing recognisable payroll thresholds, and the consultation rejected them.
The work on the development of automatic enrolment and the early legislation, led so ably in this House by the noble Lord, Lord McKenzie, gave us another solid canon to work with. Private pension saving should build on the foundation of state pension entitlement. The Johnson review gave us a solution to the de minimis level of pension contributions, via a gap between the automatic enrolment trigger and the earnings level from which contributions are collected. The lower limit of the qualifying earnings band must work hand in hand with the automatic enrolment earnings trigger to deliver the policy intentions.
The consultation rejected alignment of the lower limit of the band with the national insurance contributions primary threshold because it increased substantially this year to £7,605. We, too, rejected it. It would not deliver the policy intentions. It would be a logical point of alignment and is a recognisable payroll threshold, but it is too high a peg for automatic enrolment minimum contributions. It would reduce the gap between the trigger and the point from which minimum contributions are calculated to such an extent that we would lose the critical de minimis cushion, and then we would be back to the problem of penny-packet contributions.
We looked for a point of alignment for the lower limit of the qualifying earnings band that would deliver simplicity and maximise pensions saving. We looked for a threshold that worked in conjunction with the trigger to solve the problem of penny-packet contributions. This happens at the national insurance lower earnings limit. A worker will start to build up a basic state pension on earnings above the national insurance contributions lower earnings limit. This is £5,564 for this tax year. The national insurance lower earnings limit is a figure that will be familiar to employers. It is similar, in today’s price terms, to the original proposition of the Pensions Commission and to the original figure in the Pensions Act 2008.
Baroness Drake
My Lords, starting positively, it is most welcome that auto-enrolment will really commence in October 2012, and this order is obviously an essential part of getting to that position. The pay reference periods in the draft order and the corresponding earnings values in respect of the relevant sections of the Pensions Act 2008 are sensible. We can understand why, for example, a daily pay reference period could deliver results that were not the policy intent.
It is also pleasing that the Government have held to the definition of qualifying earnings that reflects the common pay components that make up the pay packet. Aligning auto-enrolment triggers and thresholds with tax and national insurance thresholds in the interests of simplicity for employers wherever possible would seem a sensible approach—but only to the point where the pursuit of simplicity does not undermine desirable outcomes, particularly for women.
Aligning the upper limit of the qualifying band of earnings with the NI upper earnings limit provides simplicity, complements the policy intention and, by extending the range of earnings, increases savings a little. Similarly, setting the lower limit for the qualifying earnings band to the NI lower earnings limit provides simplicity and maintains contribution levels when auto-enrolment is triggered. That is the positive.
However, our concern is that the level of earnings that triggers the automatic enrolment of a worker is set for 2012-13 at £8,105, the PAYE threshold. This further rise in the trigger excludes yet more women, and places simplicity above enabling millions of women to increase their savings pot. We remain concerned for the reasons we have rehearsed previously: raising the earnings trigger has a disproportionate impact on women and the Government are repeating the errors of the past in designing a second-tier pension system that does not work for the life pattern of many women. In 10 years’ time, the error will be obvious, particularly to women themselves. I have no doubt that action will be taken to amend it, but by then thousands of women will have lost out unnecessarily.
The Government’s response to the automatic enrolment earnings threshold consultation reports that the main focus of consumer organisations was on equality issues, particularly the impact of higher thresholds on low-paid workers, the majority of whom are women, but clearly their views are not a dominant influence in setting the trigger. Millions of women have a life pattern in which periods of full-time work are interspersed with significant periods of part-time work when their caring responsibilities are at their greatest.
On the Government’s figures, of the workers eligible for auto-enrolment, two in five—39%—are women. Raising the trigger from £5,035 to £7,475—the 2011-12 PAYE threshold—excluded 600,000 individuals, 78% of them women, most of them part-time, but that decision was made. However, raising it to £8,105 excludes another 75,000 women, on the grounds of simplicity. If, over time, that earnings trigger rises even further in real terms, tracking proposed increases in the tax threshold, the number of women excluded from the benefits of auto-enrolment will grow even more.
The effect of excluding these women is, first, that they may not start to save when the reforms are introduced. Secondly, when they transition from full to part-time jobs they may face increased charges on their pension pot accumulated as a result of becoming an inactive member. Thirdly, ceasing to be auto-enrolled when they become part-time workers could break the persistency of the savings habit they built up when working full-time.
The Government sympathise with the view that only those who benefit from tax relief should be auto-enrolled. This ignores the working of the tax credit system. For example, household income brought to account when calculating universal credit disregards 50% of that income paid in pension contributions. Of course, before the reforms it was 100%. To quote from the Johnson report commissioned by the Government:
“Many or most very low earners are women, who live in households with others with higher earnings and/or receiving working tax credits. These may well be exactly the people who should be automatically enrolled”.
Those excluded women also suffer a loss in lifetime pay, albeit deferred pay, because they do not have access to the employer’s 3%—and for some employers the figure is higher. However, they will still lose out from any lower wage growth that flows from the cost of automatic enrolment.
If policy is predicated on the belief that most people will not begin to save unless the power of inertia is harnessed through auto-enrolment then it cannot be the case that the right of those below the earnings trigger to “opt in” will seriously mitigate the risk that many women will face lower incomes in retirement as a result of the level at which the trigger is put. As to persistent low earners, the argument that they should not save because they get state pension and benefit means yet again that there will be no “asset accumulation strategy” for low earners. If 100% of pension contributions were disregarded for universal credit calculation, this would reduce the risk of a fall in people’s welfare prior to retirement.
Furthermore, if the Government accelerate the move to a single flat-rate pension, depending how that is done, together with the more generous crediting arrangements for carers introduced by the Labour Government, then the incentive to save can increase for significant numbers. As the Johnson review again observes:
“earnings are highly dynamic and there are relatively few people who have low earnings throughout their lives”.
A make-weight argument for the higher earnings trigger is that it reduces the number of small pots of pension saving, which are disproportionately expensive for the insurance industry to administer. But of course that argument is totally contrary to the policy intention. The answer to that problem is the public service obligation of NEST not to increase the numbers of workers excluded from auto-enrolment.
Much is made by large employers—though having read the review, one sees that not many of them directly make submissions—of certainty and business planning from linking the earnings trigger to the PAYE threshold, so setting the direction of travel. In 2012-13 the Government are rolling out to the large employers and are raising the earnings trigger in order to simplify the process. However, these are large firms well versed in dealing with complexity. Surely we should not be trading fairness for women, which they need, for an alleged simplicity which these companies do not require.
Many large employers have already been given the simplifying benefit of an alternative certification test. Many use salary substitution, managing the complexity of employees opting both in and out of salary substitution. They are experienced in deploying often complex measures to manage their pay and tax liabilities and frequently changing tax rules. Do 75,000 more women need to lose the benefit of auto-enrolment to give them the alleged simplicity they seek?
To return to the positive: while we welcome the commencement of the new employer duty, and recognising some of the positives in this order, we remain concerned about the position of many women that is created by raising the earnings trigger.
Lord German
My Lords, I recognise in the consultation document and in the response from the Government that three-quarters of the respondents supported the trigger that is now being set by the Government in this legislation. Of course, this is not an exact science; one cannot say that a specific figure is the level at which people will benefit from coming in to automatic enrolment. However, we should recognise that for many low earners, investment in pensions is potentially unsuitable, and that it is not suitable for persistent low earners. I will come back to that point in a moment.
When the Pensions Commission did its initial work, it stated that low earners might aim for a gross replacement rate of 80% or more of their income when they retired. The Johnson review—which I, like the noble Baroness, will quote from—stated:
“This disproportionate impact on women is something we would wish to avoid if we believed that these people would benefit from saving”.
Individuals who are low earners throughout their lifetime will receive a relatively high income—I stress “relatively”—in retirement, without private pension saving. Paul Johnson quotes the example of an individual earning £10,000 a year from the age of 22, who would see a replacement rate of around 97% from the state alone. Therefore, the question is where the target trigger should be set. Surely the objective must be to maximise pensions saving where that saving is valuable and minimise it for people for whom it will not be worth while.
There is no doubt that this will have a disproportionate effect on women, but the question is whether potentially it would not be worth their while to invest in this manner. Would they benefit from the savings? The question that is being asked here is about what the threshold should be and whether it should be somewhere in the region of the figures that Paul Johnson quoted in his review for the Government. Individuals who are low earners throughout their lifetime will receive a relatively similar income without private pension saving. The question is: does the trigger enable people to come back in when their earnings level rises above the tax threshold? The question that the Minister might like to answer is: what will be the procedure for people who have been low earners, who are underneath the trigger, who have not chosen to opt in but who reach that figure to be automatically enrolled? If they are in the category of persons who will occasionally fall back below and then rise above the trigger level, how will their re-enrolment occur? Will there be encouragement, and will they be tracked so that the re-enrolment will occur seamlessly, without them losing out?
The other way in which people’s choices could be made is through opting in. I note that the consultation response from the Government states that people will be encouraged and that employers will be required to pass on information to their workforce. However, there is a difference between passing on information and encouraging people. The difficulty that many employers will have with low earners is in determining whether this is potentially good for them. It is a very difficult judgment to make, given that it may not be the right choice for a person who is a low earner throughout their life but might be for someone who is a low earner now but who has the potential to move back and forth across the trigger line.
Lord McKenzie of Luton
My Lords, I begin by thanking the Minister for the manner in which he introduced the order—and I think I spotted a few kind words as well.
My noble friend Lady Drake set out our position with her usual precision and focus, so I will be brief. Auto-enrolment goes live in a few months and we should take this opportunity to reflect on the tremendous efforts that have been brought to bear, not least by my noble friend, to make it a reality. Although we do not have an identity of view with the Government on all aspects of its implementation, we acknowledge their role in taking this forward in challenging times. The introduction of auto-enrolment may not be preceded by a torch relay but its effect and indeed its legacy have the potential to outshine the other exciting event that we expect to experience later in the year.
Appendix A to the Explanatory Note sets out the impact of changing the earnings trigger and the upper and lower limits of the qualifying earnings band. My noble friend Lady Drake focused on our major concern: the impact of the raised earnings trigger. As she explained, far and away the biggest number of losers are women. There seems to be an implicit assumption—which was in a sense reiterated by the noble Lord, Lord German—that these would be persistent low earners. I would be interested to know what evidence there is for that. If we wanted to align it with something that had a PAYE component, what about the primary threshold, for example?
I looked at the Government’s response to the consultation. The reason given for excluding the primary threshold was that there was no tax relief at the lower end. How much work have the Government done on this? I went to the HMRC website to remind myself of the rules on tax relief for pensions. It states:
“Usually, your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions). You only pay tax on what’s left. So whether you pay tax at basic, higher or additional rate you get the full relief straightaway. However, some employers use the same method of paying pension contributions that personal pension scheme payers use—read more in the section on 'Personal pensions'”.
That section states:
“You pay Income Tax on your earnings before any pension contribution, but the pension provider”—
this is for personal pensions—
“claims tax back from the government at the basic rate of 20 per cent. In practice, this means that for every £80 you pay into your pension, you end up with £100 in your pension pot. If you pay tax at higher rate, you can claim the difference through your tax return”.
What happens if you do not pay tax?
“If you don't pay tax you can still pay into a personal pension scheme and benefit from basic rate tax relief … on the first £2,880 a year you put in. In practice this means that if you pay £2,880 the government will top up your contribution to make it £3,600. There is no tax relief for contributions above this amount”.
So the assertion that there is no tax component available simply because you are below the tax threshold is not true. I recall that the proposition was that NEST would adopt that alternative means of generating tax relief for people who went into the NEST scheme. Will the Minister outline in some detail the extent to which that issue was factored into the considerations; and confirm what the position of NEST is intended to be in relation to the routes by which people may get tax relief when it is introduced?
It is a great pity that the issue of the trigger has left us apart. The noble Lord, Lord German, instanced the fact that the tax threshold may rise to £10,000—part of a wider deal, I understand. We will see whether and when that comes to fruition, but it will simply exacerbate the problem that my noble friend Lady Drake outlined in such detail. I hope the Minister can deal with that point.
Lord Freud
My Lords, I said I was expecting a robust debate. It has been short but typically robust. What has clearly come through is that the figures around the earnings band seemed to get general acceptance in this Committee, and the real issue we are discussing is the trigger level. It is common ground that it would be pretty hard to find an earnings trigger that would target auto-enrolment perfectly. Our aim is to maximise pension saving for those for whom it is valuable, and minimise the number captured of those for whom it is not. Clearly this is not a perfect science.
The rise in the value of the trigger takes us to the impact on the low paid. As noble Lords pointed out, on balance many more women are in this category—in particular years, though it may not be a continuous position. I should put on the record that the rise from the £7,475 threshold to £8,105 excludes does not exclude 75,000 women; the figure I have is 100,000. We might as well get that on the record. Of those affected, my information is that 82% are women. We recognise that women are more likely to work part time or work less than men, and that they will be disproportionately represented in the group excluded from automatic enrolment by the increase in the trigger.
With the trigger, and automatic enrolment generally, we are talking about soft compulsion. We have developed a system that aims to capitalise on inertia—the default is saving, but we have left people who are new to pension saving to opt out if they consider that they really cannot afford it. Automatic enrolment with an employer contribution is an incentive to save. For the first year, certainly, we do not want to encourage people who do not earn enough to pay tax to divert wages into a pension pot unless their circumstances mean that it makes financial sense.
A question was asked based on reading three pages of the HMRC site, which was very assiduous. Tax relief was one of the factors considered, but not the only one. Maintaining an adequate gap between the trigger and the bottom of the earnings band was also relevant. We also needed to make sure that the right people—those who could afford to save—were enrolled.
There are two ways for a pension scheme to access tax relief for individuals. As the noble Lord, Lord McKenzie, said, schemes using relief at source can get tax relief at the basic rate even if the individual is not a taxpayer. However, where a scheme uses a net-pay arrangement, individuals can get tax relief only if they have taxable earnings. To answer the specific question, NEST will use the former, so that all members can get that tax relief.
Lord McKenzie of Luton
Does that mean that the tabulation in the Government’s response—which says that if the trigger is set at the primary threshold, it is not tax relievable at the lower end—would only run in some circumstances and would not run for many scheme members, particularly if they were members of NEST?
Lord Freud
Yes, on the basis of what I have just said, that is quite clear. For those saving in NEST, the figures would not work, while those saving in some other way, as the legislation currently stands, would not get the relief. NEST: yes; others: no. I think the silence behind me suggests a good spot there and I suspect we may look at that particular issue or anomaly —we may.
With the gently-gently approach of phased contributions starting at a modest level, we hope that we will not trigger a rush to the exit, but we do not know. We know what people tell researchers when they are asked. We can look at the opt-out rates in those countries that have similar systems. However, in the end, the evidence shows that if people feel they cannot afford it they are more likely to walk away, and the whole issue of pensions stays in the “too difficult to think about” pile. We are feeling our way here and there will be chances to make adjustments.
Baroness Drake
I appreciate that the Government are looking at the whole issue of the transfer of small pots. The point that I sought to concentrate on was that it is very likely that the market will apply a differential charging structure to inactive members and to active contributing members. Even though the Government have taken powers to control that, those powers will not stop differential charging. If a woman is full-time, then takes on a part-time job with another employer and is not auto-enrolled—and so becomes an inactive member—one of the consequences is that the charges on her remaining pot start to rise, because inertia is not turned into a positive. It is that narrow point. I appreciate that the wider review of pension pot transfers is coming up.
Lord Freud
I will stand my ground a little bit on this, because these are some of the issues that really come into consideration when we look at the broader issue of pension pots. My colleague Steve Webb has said a few things about this in public, and I know that he is looking in private at this differential charging issue, so it is something that he is considering.
My noble friend Lord German asked a related question about the opt-in/opt-out rates. Those will be monitored on an ongoing basis. He also asked about people coming in and going out as their earnings change, perhaps going from full-time to part-time. These people will continue to make and receive contributions according to the rules of the scheme that they end up going into when they go in, but if earnings dip to the extent that no contributions are due in a particular period, they will restart immediately when their earnings are high enough, so there is no waiting period.
I will now return to two issues to deal with them precisely. I only touched on the differential charging that the noble Baroness was concerned about. We have powers under the 2008 Act to set a cap should charges become inappropriately high. We recently extended those powers to cover deferred members. Therefore, we have all the necessary powers, and my colleague is aware of the issue. We are monitoring the charges with rolling research and will continue to do that as enrolment is brought in.
I will close my answers by doing justice to the point about tax relief made by the noble Lord, Lord McKenzie. We will continue to take that into account. The matter is not entirely straightforward, as we established. At this stage we do not know how many people will get relief at source as opposed to making net pay arrangements. We will keep that matter, too, under review.
This is our first review. It took a major consultation effort to decide on the trigger and the earnings band. We would have preferred to come out with this earlier, and I will try to do better on timing next year because early certainty is important, for employers in particular. It was right to consult this time, and to gather the views of people who will need to make automatic enrolment work in practice: those who will have to administer pension schemes, employers who will have to deal with all the questions from their workers, and people who represent those workers. The one message that we got from all of them was that we should keep this simple. I shall take that to heart for the future. Of course, it chimes with the Government’s Red Tape Challenge.
As I said, we will come back to this in a little less than a year. I know that I look forward to it as much as other noble Lords in the Room. I commend the order to the Committee.