The Second Pensions Commission is evaluating the UK automatic enrolment system, with a potential change that could see the lowest-earning third of employees face a four per cent reduction in take-home pay, according to research from the Institute for Fiscal Studies (IFS).
The proposed scenario would increase minimum pension contributions from the current 8 per cent (with 3 per cent from employers) to 12 per cent, and apply this from the first pound earned rather than only on earnings above £6,240. The IFS found that under this model, the lowest-earning third of employees could see their pay packets shrink by four per cent.
This is not yet Labour Party government policy, but the IFS has put forward the contribution hike as Prime Minister Andy Burnham and Chancellor John Healey consider their options. The commission is responding to an estimated 15 million working-age people who are undersaving for retirement.
Current rules and the undersaving problem
Under current rules, workers must contribute a total of at least 8 per cent of their earnings between £6,240 and £50,270, with employers contributing at least 3 per cent. However, experts warn that this may not be enough to maintain living standards in later life, potentially leading to a drop in retirement income.
The IFS research examined several scenarios for increasing contributions. The 12 per cent option, if applied from the first pound earned, would have the most significant impact on lower earners, who would see a four per cent cut in take-home pay. This would affect the lowest-earning third of employees, a substantial portion of the workforce.
Industry reaction to potential reforms
Mark Stansfield, senior actuarial consultant at Hymans Robertson, said: “Retirement adequacy is increasingly becoming a business issue, not just a pensions issue. Many employers are already dealing with the effects of employee financial stress and changing working and retirement patterns, all of which can impact productivity, workforce planning, and long-term business performance.”
He added: “While potential future reforms such as changes to automatic enrolment and higher contribution requirements would increase employer costs, they may not solve the adequacy challenge for every workforce.”
Hannah English, head of DC corporate consulting at Hymans Robertson, urged employers to consider pension design as part of their broader workforce strategy. “Employees need to balance long-term saving amongst day-to-day financial pressures,” she said.
“However, for many, retirement saving still feels distant, and many may fully start to understand the scale of any retirement shortfall once dashboards make their pension position more visible. The question is not simply whether contributions should rise, but whether current support is helping different groups achieve better retirement outcomes in a sustainable and fair way.”
Impact on workers and employers
The potential change would increase costs for both employees and employers. For the lowest-earning third, the four per cent reduction in take-home pay could be significant, affecting their ability to meet day-to-day expenses. Employers, meanwhile, would face higher contribution requirements, which could impact their workforce planning and overall business costs.
The commission's evaluation comes as the government seeks to address the retirement savings gap. With 15 million working-age people undersaving, the need for reform is clear, but the trade-offs between higher contributions and immediate income are a key consideration. The IFS research provides a basis for understanding these trade-offs, but any final decision rests with the government.
