Many of the people who will be auto-enrolled into pensions from 2012 will be on relatively low incomes, meaning the contribution rates will be lower than the benchmark of eight per cent, says Watson Wyatt.

The financial consultant has picked up on information supplied to Parliament this week, and has calculated that the eight per cent minimum contribution will, in fact, never be more than 6.8 per cent of gross earnings. Following in a phasing in period, the minimum contribution rate will be eight per cent of qualifying earnings, of which at least three per cent must be contributed from the employer. Qualifying earnings are based on income between £5,035 and £33,540.

However, figures published by the Department for Work and Pensions (DWP) actually shows that this will be far less, because the median income of relevant employees was just £17,000 in April 2007, and 19 per cent earned less than £10,000. Therefore, a significant chunk of their income is ignored when calculating the statutory minimum contributions.

Watson Wyatt has calculated that for around half of those who fall into the auto-enrolment band will contribute 5.6 per cent of gross earnings or less, their 'equivalent' to the eight per cent barrier. One in five will contribute less than four per cent, and for around half of the band will benefit from minimum employer contributions of 2.1 per cent of gross earnings or less.

"The way the system has been designed makes it important not to exaggerate how much money will be going into people's pensions," said Paul Macro, a senior consultant at Watson Wyatt. "It is dangerous to slip into a shorthand way of speaking and say that eight per cent will be paid into employees' pensions. The real question is: eight per cent of what? Typically, the minimum contribution rates amount to less than six per cent of pre-tax earnings."

Macro is concerned that people will have an "exaggerated impression" of how much is put aside for their retirement, and believes people should look at their pension in relation to their income and decide whether they can afford to save more.

"When so many of the target group are on low incomes, it is doubly important to make life easy for employers who want to maintain defined contribution schemes which use basic pay to calculate contributions. For someone on £17,000 a year, a three per cent employer contribution will be worth £510 if based on their whole salary but only £359 if based on banded earnings."

- Pensions Age March 2009

Share Story: