The pensions submarine will sink low earners with auto-enrolment torpedos

 
Graeme Leach
An officer looks through the periscope o...
Source: Getty

I watched Dunkirk last night and one scene in the film neatly captures an unseen threat to the UK economy at present.

In the scene, soldiers who have escaped the horrors of the beach are seen on board a destroyer drinking tea and congratulating each other that they’re free from Stuka dive-bombers. But they’re not safe, as the cry “torpedo in the water!” bellows out.

The analogy with the contemporary economy is that in the wake of The Great Recession, and the debates over the impact of extraordinary monetary policy and fiscal austerity, we have ignored a threat that has been sitting in wait submerged.

The threat was the pension auto-enrolment submarine launched in 2012. It fired its first torpedo when the employer and employee minimum contribution of one per cent each was introduced for large employers. The torpedo missed its mark and its effect was unseen amid the explosions from the banking crisis all around.

But now the submarine is moving into position to fire multiple torpedos with no sign whatsoever of evasive action by policymakers. Next April the torpedos will be in the water and armed.

For employers, the minimum contribution of one per cent of salary rises to two per cent next April, and three per cent the following year. For employees, the contribution rises from one per cent to three per cent next April, and five per cent the following year. According to the latest numbers from The Pension Regulator, 8.3m employees working for over half a million employers, have a workplace pension as a direct result of auto-enrolment. This figure will continue to grow.

For all those contemplating the absence of a negative relationship between unemployment and wage growth, here may be part of the answer. There is a big difference between wages and wage costs.

The UK unemployment rate stands at 4.5 per cent, the lowest figure since 1975. Earnings, including bonuses, are rising just 1.8 per cent.

In real terms, headline earnings growth is falling, given CPI inflation of 2.6 per cent. This is the view from employees. From an employers perspective, however, what matters is total wage costs, not wages alone.

Add in the costs of auto-enrolment to headline wage growth, and the story changes. For firms now auto-enrolled that weren’t previously, there is another one percentage point to add to 1.8 per cent earnings growth. This unseen threat will explode next April when the employers contribution rises to two per cent, and three per cent a year later. Throw in the introduction of the National Living Wage at £7.50 per hour in April 2017, and the need for employers to seek restraint in the wage component of total wage costs becomes obvious.

The impact on employees, however, will be even greater. Already reeling from a 0.8 per cent fall in real earnings growth, auto-enrolled employees will see their contribution triple to three per cent. If that doesn’t sink them, the five per cent follow-up torpedo will decimate them a year later.

Auto enrolled workers – often on low incomes – are already experiencing falling real wage growth and their “take home” pay is set to fall by a further four per cent between now and April 2019. This is a political storm in waiting. While working at the IoD, I warned ministers in 2012 that this is exactly what would happen. They weren’t interested then. Are they now?

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

Related articles