Everyone to have a pension
If you’ve got a job, be aware from 2012 EVERY employee will automatically start paying some of their earnings into a private pension (though you can opt out). And today news is out that “2% of that contribution” to the new NEST pension scheme will be eaten up by charges – not a particularly cheap scheme…
So is this a question of feathering the nest – is the charge too high a price for pensions for all?
I’ve been trying to square all this in my head today – so I thought I’d note down the basics and mull my thoughts as I do – I’d love to hear yours too…
What’s going to happen…
In 2012 we’re due to see the biggest change to UK pensions for a generation, every employee (not self-employed) will be auto-enrolled to start contributing to a private pension. On current plans it’ll start at 1% but rise gradually to 4% – employers will be forced to roughly match it too and there’ll be tax relief.
Let me put this in a rather stark way with two phrases that seem contradictory but are both true (for those who don’t already have private pensions):
EVERYONE WILL GET A PAYRISE
EVERYONE WILL GET LESS IN THEIR PAYPACKET
The payrise is because your firm will need to contribute to your pension, effectively giving more money to you – though as that goes into your pension and you have to put cash in from your own paypacket you’ll get less disposable income.
This is all about push economic
This is the first big UK test of the push economics theory – which in a nutshell says you set up the system so people default to the correct action – so they need choose not to be effected. Here that means you’re automatically opted in to the pension though crucially it’s not compulsory – you can opt out if you want to. The basic mechanics of the system have support across all the main parties though there are some minor disagreements over exact format.
Overall I’m a big fan of this too, we need to help people to help themselves and inevitably most of us are guilty of decision making focused on the now, not the future, no where is that more important than pensions…
Why we need pay into our pensions.
With an aging population, the state pension is simply not going to be able to produce an adequate retirement plan for everyone. I quite deliberately use the term ‘cold baked bean future’ to describe those relying on this for their retirement – as the reality needs to be seen as a stark one to help people relalise they well prepare.
Looked at in a personal basis the equation is pretty simple (I’ve not sourced these stats, they’re rough estimates):
- Life Expectancy = 80 -85
- Typical working life = 35 – 45
- Percentage of life worked = 41% – 56%
There’s no magic here, we work half our lives and the income earned in that period must pay for the rest of it.
It could be argued “our parents pay when we’re kids,” yet that is simply commutative and therefore we can allocate the amount you pay for your children to be the equivalent of what was paid for you to grow up in real terms. So the equation works.
Should we put half of what we earn away?
On the above basis you could argue that we should save away half of what we earn for our future, thankfully there are a few reasons it doesn’t need to be this much, namely:
- Kids are paid direct. The 50-50 equation includes paying for your offspring, this tends to be done during your working life, so there’s no need to save away extra to provision for it.
- State benefit. Some of our earnings go towards paying tax for national insurance – which gives us the rights to a state pension. While many who live on it struggle, it means there is already effectively an automatically enrolled pension system – this new one is a top up.
- Compound interest. Making the (sometimes questionable) assumption that over time money invested on average grows, then the earlier you invest the more that cash grows in real terms. Therefore putting a pound away for retirement in your 20s is equivalent to putting perhaps four times the amount in your fifties, as it’s had time to grow.
No 'cold baked beans' future
Factor all those things in and thankfully we need contribute way less than half of what we earn – but still the old rough rule of thumb (see the stakeholder pensions guide, is pretty scary…
“Take the age you start contributing (e.g. 36) and HALVE it (18). This is the percentage of your salary to put in every year until to retire with income equal to 2/3 of your final salary. So the younger you start the better, but it’s still a HUGE sum.”
Now that’s enough to put anyone off – but don’t be. Start with whatever you can afford – even £10-a-month – and my tip is, if you get a pay rise, put 25% of the monthly increase into your pension before you get used to it. It’ll help build a decent contribution.
How much will be saved under the new scheme
While I’ve heard contradictory amounts, under the new scheme, the contributions will be tapered up for the first few years and then from 2017 hit this:
- Employee contribution 4%
- Employer contribution minimum 3%
- Tax relief 1% (when you pay in a pension you do it from your pre-tax salary meaning put £100 in and it only costs a basic rate taxpayer £80 from their paypacket)
That means people will be putting aside 8% of their salary to a pension – a pretty decent whack which should produce (if my memory from discussing this with pensions minister Angela Eagle a few months ago is right) an estimated 45% of final salary as a pension for most. My only problem with all this is the level of contribution is fixed for employees – either you put the whole 4% in or not at all.
This is quite a serious amount to take from people’s pay packet and my worry is people will opt out if they can’t afford it, thereby forgoing the effective payrise from their employer. My first thought is I’d prefer an auto-enrolment at 4% but with the ability to opt down to 2% or opt out completely.
Feathering the Nest?
Start building your nest egg now
To administer this huge wave of new pension contributors the government is setting up the National Employment Savings Trust (NEST) – which will in one fell swoop become the biggest pension company in the UK (and possibly Europe?)
The charges on investments with it will be 0.3%, but today it’s being reported that as the government won’t be subsidising the vast set up charges needed for nest – until 2030 there will be an additional 2% charge on contributions.
You can read full details of this in the High Government pension charges to last until 2030 news story – do note this particular article is sourced from the PA newswire, not written by MSE team and the angle of it is rather interesting…
How high are the new charges?
When I first read the story I was considering writing a blog on how ridiculously high these charges are then I read it carefully.
This is a 2% charge on CONTRIBUTIONS – not on the entire amount invested which is how charges are normally phrased.
So doing a back of the envelope calculation (any pensions nerds do let me know if I’ve missed something):
Charge on everything: 0.3%
Charge on employee contributions: 2%
Proportion of overall contribution coming from employee: 50%
Total overall charge: 1.3%
This isn’t cheap – but nor is it monstrously expensive compared to most pension funds out there. And let’s remember the complaint from some is “the Government should subsidise this” but of course the government doesn’t have any money of its own it comes from taxpayers – so is it fair those who won’t be using the scheme subsidise those who do?
So that’s my initial mullings – I would love to hear your- thoughts on it…
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