Martin Lewis: A warning to every UK worker aged 22 or over – you’re likely about to get a pay rise, but it may cost you
On 6 April 2019, most UK workers aged 22 or over are due a hidden pay rise – but your employer needn't tell you. This is all about 'auto-enrolment', where your employer must contribute towards your pension. Now it'll have to give you even more, though then again, you'll have to shell out much more too. So I'm bashing out this blog to take you through it.
Auto-enrolment is a scheme that says companies must opt in their employees (aged 22 or over and earning at least £10,000 a year from one job) to pay towards a private pension – a savings plan 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're saving into one of these auto-enrolled pensions (ie, unless you opt out), the firm must also contribute to this 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 – by the largest amount we've seen.
And that means those who currently put in only the minimum (which is automatic 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.
NB: For many people, a little of this increase is likely to be offset by the 2019/20 income tax rates, which come in at the same time and mean many people will be taxed less on the same earnings.
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 is unlikely to apply if it meets the minimum standards set by auto-enrolment for default funds, charges and contributions.
Opting out of auto-enrolment is a mistake for most
Don't opt out unless it's a last resort, because that means in effect you're giving up extra money from your employer. Of course, if you're struggling, you may be tempted, as losing disposable income is hard to bear.
However, 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 let me reiterate that thankfully the lazy option of DOING NOTHING means you'll 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 sacrificing the future for the now. This way, make no decision, and it's hopefully the right one.
What’s changing on 6 April 2019
We saw increases on 6 April 2018 and this year's are going to be even bigger. There are two main changes coming in...
- The minimum your employer has to contribute is to increase from 2% of your salary to 3% (so £100 a year extra per £10,000 of salary).
- The minimum total auto-enrolment contribution is to rise to 8% (that's the total that you and your employer together must put in).
So if your employer is only putting in the minimum 3%, your contribution will automatically rise to 5% to meet the maximum total (so a £200 per £10,000 increase), without you doing anything. If it is putting in more than the minimum, your contribution will not have to rise by as much to meet the total (eg, if it puts in 4%, yours will only rise to 4%).
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.
There is a chance your employer already has 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 checking.
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. Some schemes allow you to choose to contribute more, others will let you select to pay less than the minimum and still get some employer contribution. So if you're thinking of cancelling because this rise is too much, at least see if you can just drop down.
How to pay HALF the cost for what goes into your pension
In the next tax year, 2019/20, the tax for most people works roughly as follows (see our Tax Rates guide for thresholds for taxpayers in Scotland)…
- The personal allowance on earnings is rising to £12,500 (the amount you can earn before paying income tax).
- On income from £12,500 to £50,000 you pay the basic 20% rate of tax.
- On income above £50,000 until £150,000, you hit the 40% rate.
- On income over £150,000 you pay 45%.
Yet pension savings come from PRE-TAX salary. Putting £100 a month in your pension (the likely contribution of someone on a typical £24,000 salary paying 5%) only reduces a basic rate taxpayer's pay packet by £80, a higher 40% rate taxpayer's by £60.
As we've said, on the minimum level, if your contribution is 5%, your employer must put in 3%. So if you are putting in £100, your employer would put in £60, meaning a total of £160 is added to your pension. But that only costs you £80 (£60 at higher rate) – in other words, half the cost. Or even less with salary sacrifice (see FAQ below).
Over a year at this level of saving you'd pay £960 (£720 higher rate) but your pension would have £1,920 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, so you can use our 10-minute benefit checker or speak to Citizens Advice to find out.
- 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 £1,030,000 (rising to £1,055,000 in April). 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 a proportion of your monthly earnings and ask for your employer to contribute it to your pension instead. This reduces your and your employer's national insurance contributions but some or all of this goes into your pension.
In some cases generous employers will add part or all of the gains they've made from national insurance into your pension. Your national insurance saving will be added too, and there's the tax saving as well.
Everybody's individual finances are different, so using a salary sacrifice calculator will give you an indication of how much you'll pay into a scheme over the next few years. Try this calculator from the Pensions Regulator.
Technically salary sacrifice does mean your take-home pay will be reduced a touch, which while not usually an issue, could also affect eligibility for mortgage applications, earning or contribution-based benefits such as state pensions, maternity allowance or incapacity benefit (should you need to claim any of these in future).
Q. How much should I save towards my pension?
A. Be prepared to have the pants scared off you. Here's a rule of thumb that shows how much you should put in your pension for a comfortable retirement – which will deliver you the equivalent of an income of broadly two-thirds of your final salary for the rest of your life.
Take the age you started your pension and halve it. This is the percentage of your salary that needs to be saved 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, and 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 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 out too much 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 property prices rise, at retirement it's not easy to spend the home 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. Lifetime ISA (LISA) is a savings account that 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 for higher-rate taxpayers.
That's just the tip of the iceberg. For 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.
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