On 6 April, most UK workers aged 22 or over are due a hidden pay rise – but your employer doesn’t need to tell you. This is all about the ‘auto-enrolment’ scheme – where your employer has to contribute towards your pension, and now it’s going to have to give you even more. So I wanted to bash out this blog to take you through it.
Auto-enrolment is a scheme which says companies must opt in their employees (aged 22 or older and earning at least £10,000 a year) to pay towards a private pension – a savings scheme to provide money for you in later life, on top of the state pension.
In other words, even if you do NOTHING, some of your salary will be put towards saving for a pension rather than be part of your take-home pay. Plus if you are saving in a pension (ie, unless you opt out), the firm must also contribute to this pension fund – on top of your salary.
The reason for writing this now is that when the new tax year starts on 6 April, the minimum amount you and it must contribute will increase substantially. And that means those who currently only put in the minimum (which you will do automatically unless you’ve requested a change) will see their contributions increase too.
The effect is a bit of a mind twist…
- EVERYONE WHO IS OPTED IN EFFECTIVELY GETS A PAY RISE… as your employer is giving you even more money you wouldn’t have otherwise got, even though it’s not immediately usable.
- EVERYONE WHO IS OPTED IN GETS LESS TAKE-HOME PAY… to get the extra money, in most cases you’ll have to contribute more now too; so your disposable income, the amount you can spend each month, is reduced.
As a note – for most people a little of this increase is likely to be offset by the changes to income tax rates which come in at the same time and mean most people will be taxed less on the same earnings.
Plus or those with outstanding student loans it could also be offset because the threshold for repaying those is due to rise substantially (the subject of my next blog). And of course you may be lucky enough to have been given an actual pay rise.
If your company gives you a final salary pension, where the amount you get is based on the number of years you worked for it and your final salary, this doesn’t apply.
Opting out of auto-enrolment is a mistake for most
Don’t opt out unless it’s a last resort, because that means you’re effectively giving up extra money from your employer.
Yet of course if you’re struggling, you may be tempted, as losing disposable income is hard to bear. But not doing it means giving up extra cash, and in turn that means running the risk of a cold baked bean retirement, as whether in future the state pension alone will be enough to live off is questionable. This is about saving now, so your living standards don’t plummet later.
So it’s probably a good point to reiterate that DO NOTHING and you will automatically be saving towards your pension. I’m in favour of this. Many people are scared of making financial decisions, and inevitably most of us are guilty of focusing on the now, not the future. This way, make no decision, and it’s hopefully the right one.
What’s changing on 6 April
For the 2018/19 tax year, there are two main changes…
– The minimum your employer has to contribute increases from 1% of your salary to 2% (so £200 a year per £10,000 salary).
– The minimum total auto-enrolment contribution rises to 5% (that’s the total that you and your employer together must put in).
So if your employer is only putting in the minimum 2%, your contribution will automatically rise to 3% to meet the maximum total – without you doing anything. If it is putting in more than the minimum, your contribution will rise to meet the difference.
And this year’s changes aren’t the last. It’ll change next year too, as this table shows.
Change to minimum contribution in pension pot
|From 6 April 2018||2%||5%|
|From 6 April 2019||3%||8%|
However, as I’ll explain in a moment, your contribution is from your pre-tax salary so it actually costs you less than it sounds.
It’s worth noting your employer may also have a much more generous scheme, in which case these minimums are irrelevant and you may not see a change. There are some rare cases where employers will put in double whatever you put in – it’s worth finding out.
And note too, this is the ‘auto-enrolment’ minimum, so you don’t have to stick with it, you can opt to change what you do. Your scheme may allow you to opt to put in more, or put in less and still get some contribution from your employer. Check with it.
It costs as little as £36 to get £100 added to pension savings
In the 2018/19 tax year on earnings over the £11,850 personal allowance, you’ll pay the basic 20% rate of tax until your earning’s hit £46,350. Above that it’s higher 40% tax (unless you’re a seriously high earner, above £150,000, when you hit the top 45% rate). The figures are slightly different for Scottish taxpayers – see income tax thresholds.
Yet pension savings come from PRE-TAX salary, so putting £60 a month in your pension only reduces your pay packet by £48 (£36 for higher 40% rate taxpayers).
Plus on the minimum level, if you put 3% in, your employer has to put in 2%. That means, even with the minimum contribution, if you put in £60, your employer would put in £40, so there’s a total £100 added to your pension, but that only costs you £48 (£36 at higher rate) – or even less with salary sacrifice (see the FAQ below).
Over a year at this level of saving you’d pay £576 (£432 higher rate) but your pension would have £1,200 added to it. That’s unbeatable.
Is there anyone who should be opting out?
If you really can’t afford to contribute to your pension, you’ve a right to opt out, or lower your contributions if your firm allows it.
Though think carefully before you do – generally you’re sacrificing long-term cash for short-term gain. However, there are some circumstances where opting out, or reducing contributions, does make sense, including…
– If you’ve very expensive debts, eg, payday loans or bank charges for busting your overdraft limit. Here it’s likely worth clearing these before you start to contribute to your pension. Then opt back in to auto-enrolment afterwards.
– If you’re near retirement and have little savings. There is a chance that having a bigger pension pot could reduce your benefits, but this is a rare scenario.
– If you already have a pension, especially if it’s a large one, there is a risk auto-enrolment will put you over the lifetime allowance, which is currently £1 million. If you already have this or other complex pension arrangements, it’s worth speaking to your independent financial adviser. If you don’t have one, speak to Pension Wise.
My quick auto-enrolment FAQs
Q. I’ve heard I can get more via pension salary sacrifice. How does that work?
A. This is where you give up monthly earnings, say £100, and ask for your employer to contribute it to your pension instead. This reduces your and your employer’s national insurance contributions, which means you get more in your pension.
In some cases generous employers will add the gains they’ve made from national insurance into your pension too, adding even more. So if we look at the example above, instead of it costing a basic-rate taxpayer £48, it could actually only cost you £41 to put in £100.
Technically though this does means your ‘salary’ has been reduced a touch, which while usually not an issue, could also affect eligibility for mortgage applications, state pensions and benefits, such as jobseeker’s allowance (should you need to claim it in future).
Q. How much should I save towards my pension?
A. Be prepared to have the pants scared off you. There’s a rule of thumb that shows how much you should put in your pension for a comfortable retirement – roughly half to two-thirds of your final salary.
- Take the age you started your pension and halve it.
- This is the percentage of your salary that needs saving each year until you retire (thankfully it includes your employer’s contribution too). So someone starting aged 20 would need 10%, aged 30 would need 15%.
For most people these amounts are impossible, so don’t get too hung up on it. Instead just use it to realise that a) the sooner you start, the better, b) put in as much as you can afford – especially if it gets your employer’s contribution up to the maximum.
One trick to boost your pension contribution, if you’re lucky enough to ever get a pay rise – immediately put a quarter of the new money towards your pension. That way, because you’re not used to earning it, you won’t miss it as much (I call this the ‘forgotten gold technique’!).
Q. Aren’t private pensions a waste of cash?
A. You often hear people, especially those currently near retirement age, swear about how their pension has massively underperformed. Well that’s simply not true. You may be surprised to read that no private pension has ever underperformed.
OK, I am playing a little with words here, but this all stems from a fundamental misunderstanding of what a private pension is. It’s not a product. It can’t underperform. It’s just a special wrapper everyone is given by the Government with the huge advantage that you save from pre-tax salary.
The problem is that historically most people invested their pension savings in ‘with-profits’ funds and these were often crap and many substantially underperformed. Yet don’t blame the pension wrapper for what was put inside it.
These days the choice of investment is much better, with lower charges and more transparency. Your firm’s pension provider should give guidance on what your options are.
Much of the choice is about ‘investment risk’. That sounds scary, but higher risk means you’re aiming for fast growth, but accept the fact there’s a bigger chance it may shrink. The younger you are, the more room you have to take some risk, as if it goes wrong, there’s more time for things to even out.
Q. When can I take my pension money?
A. Pension money can now be taken at 55, but it’s better to leave it until you need it. You’re usually allowed to take 25% of your pension as a tax-free lump sum. And with the rest you can simply withdraw it as cash if you want, but you must pay income tax on that.
The danger is, if you take too much out in one year, it pushes you up a tax bracket, which means you pay more than needed, so it’s important to plan how you get the money out. Full help in my free Taking your pension booklet.
Q. Isn’t property better than a pension?
A. There’s nothing wrong with buying property, though of course you pay for it from your AFTER tax-salary; your employer won’t contribute. Plus even if house prices rise, at retirement it’s not easy to spend the house you live in, unless you sell or downsize, so it’s only a paper gain. Though a mortgage-free property does reduce your outgoings.
So both have advantages – if you’re fortunate enough to be able to do both, that of course is a boon.
Q. Isn’t a LISA a better way to save for retirement?
A. A Lifetime ISA (LISA) is a savings account which can be used by many first-time buyers and those looking to save towards their retirement. It looks attractive as the state adds a 25% bonus on top of what you save and the interest.
But if you’re an employee, it is unlikely to be a better option than a pension. First, because there’s no ‘employer’s contribution’ bit with a LISA. And while the 25% bonus sounds good, you save in a LISA from after-tax money, so this works out about the same gain as putting money in a pension pre-tax for a basic-rate taxpayer, and worse than for higher-rate taxpayers.
That’s just the tip of the iceberg. For a more detailed analysis, see my LISA vs Pension info.
Q. Isn’t there a risk the employer will take my cash?
A. I published a guide to auto-enrolment a couple of years ago, and I was surprised to get comments akin to “I won’t contribute because what happens if the firm loses money, like happened with BHS, then reduces the pension payout?”
Yet that’s a confusion. That isn’t auto-enrolment. It’s a totally different type of pension scheme (a final salary scheme). So rest assured, with auto-enrolment, you save a pot of money, your employer adds to that pot and that cash is held for you by an investment firm – the company has nothing to do with the money.
So the amount you’ll have in your pension pot when you retire simply depends on 1) how much you have contributed to it and 2) how well the investment performs (after charges); rather than anything to do with the fortunes of the company you work for.
I hope you find this useful – do let me know your thoughts below.