Martin Lewis: An important warning to every employee in the UK

This is a warning for every worker in the UK. Have you turned down a pay rise without realising it? Millions have – around 10% of the workforce currently – and many others risk doing it, unaware of the consequences. It happens when your employer 'auto-enrols' you into a pension scheme, but you decide to opt out – in most cases, a huge mistake.

Video: Why you should avoid opting out if you can

The easy way to start is by watching my new basic video explainer, which was part of my ITV Money Show pensions special (17 Feb 2022). Then you can read on for the full details. For more pensions issues, including how they're taxed, if you should consolidate and more, click the link to watch the full programme.

Martin explains why you should avoid opting out of pension auto-enrolment
Embedded YouTube Video

Turn on subtitles by using the closed captions icon in the bottom right.

What is pension auto-enrolment, and why does it mean a pay rise?

Auto-enrolment is a rule which says companies must opt in their employees aged 22 to 66ish (state pension age) who earn at least £10,000/year to pay towards a private pension.

If you're under 22, over 66 or earn under £10,000 click this link as there is still a way to make your firm pay into your pension.

This type of pension is just a savings scheme to provide money for you in later life, on top of the state pension. And it's worth it, as there's far from any guarantee that the state pension will provide a decent standard of living in future years.

Yet crucially, when you pay into your workplace pension, your employer must also contribute to your pension savings – on top of your salary. If you opt out of the pension scheme, you don't get this extra cash. The effect of this is a bit of a mind twist...

  • EVERYONE WHO IS OPTED IN EFFECTIVELY GETS A PAY RISE… as your employer is giving you extra money you wouldn't have got otherwise, even though it's not immediately usable.

  • EVERYONE WHO IS OPTED IN GETS LESS TAKE-HOME PAY… to get the extra money, you are saving from your current salary; so your disposable income, the amount you can spend each month, is reduced.

Just to reiterate, DO NOTHING, and legally the default setting is some of your earnings are put towards pension saving. 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 on the future. This way, make no decision, and it's hopefully the right one.

You can make your employer add up to 3% on top of your salary

The minimum amount that must be contributed has gradually increased since auto-enrolment started. The current minimum contribution hasn't changed since April 2019. There are two sets that must be made into your pension pot if you qualify for the firm to put contributions in...

- The minimum your employer has to put in is 3% (on earnings between £6,240 and £50,270, if you earn more, they can cap it as if you earned £50,270).

- The minimum total auto-enrolment contribution is 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 be 5% to meet the minimum total – without you doing anything. 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 that your employer may also have a much more generous scheme, in which case these minimums may be irrelevant. In fact there are some rare cases where employers will double whatever you put in or your scheme could allow you to opt to put in more, or put in less and still get some contribution. Do check.

It costs as little as £80 to get £160 added to pension savings

In the 2023/24 tax year, on earnings over the standard £12,570 personal allowance, you'll pay the basic 20% rate of tax until your earnings hit £50,270. Above that, it's the higher 40% tax, unless you're a seriously high earner, above £125,140, when you hit the top 45% rate. Figures differ for Scottish taxpayers.

But pension savings come from PRE-TAX salary, so putting £100 a month in your pension only reduces your pay packet by £80 (£60 for higher 40% rate taxpayers).

Plus at the minimum level, if you put 5% in, your employer has to put 3% in. That means even with the minimum contribution, if you put in £100 a month, your employer would put in £60, so there's a total £160 a month added to your pension, but that only costs you £80 (£60 at higher rate).

Crucial pension maths

  Basic 20% tax payer Higher 40% tax payer Top 45% tax payer
You contribute (pre-tax) £100/mth £100/mth £100/mth
Employer adds +£60/mth +£60/mth +£60/mth
Total saved £160/mth £160/mth £160/mth
Cost to you (amount take-home pay reduced by) £80/mth £60/mth £55/mth

Over a year, at this level of saving, you'd have your pay packet reduced by pay £960 as a basic rate taxpayer (£720 higher rate), but your pension would have a whopping £1,920 added to it. That's unbeatable.

It is worth noting, for many employees, the tax gain is automatic, but if your employer operates its pension under the 'relief at source' scheme (as opposed to net pay), you'll only get 20% tax-relief automatically. So if you're a higher-rate taxpayer you should double check you claim the extra you're entitled to.

Now that's the main stay of the blog over, but as I'm writing, and there are always questions when people are thinking about auto-enrolment pensions, let me quickly bash out answers to some of the most common on this...


Q. How much should I save towards my pension?

A. Be prepared to have the pants scared off you. There's a very rough 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.

  1. Take the age you started your pension and halve it.
  2. 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%, while someone starting aged 30 would need 15%.

For most people these amounts are impossible, and far above auto-enrolment levels, 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.

And here's a nifty little 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. 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 many 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. Pension cash can be taken from age 55

A. Pension money can be taken at age 55, but even at that age it is usually better to leave it until you need it. You're 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. You can get more help on how this all works, and how to take money tax efficiently from the Government's free Pension Wise service.

Q. Isn't property better for retirement than a pension?

A. This is a very common question, many ask it. Yet in fact, in many ways it's a misunderstanding, as pensions and property are like chalk and ducks. They're totally different things.

A pension is a tax wrapper you use to save assets or investments in for retirement. Property is an asset class, something you own. In fact, you can put some types of property investments within a pension (though not the home you live in).

Yet having said that, I know what most people mean when they ask they question, so let me answer with that in mind. 

Unlike a pension, you pay for property from our AFTER tax salary and 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, downsize, or do equity release so it's only a paper gain. Though, a mortgage-free property does reduce your outgoings, which is a big help to ease living costs. 

A pension on the other hand is money which you should be able to spend when you need it – supplementing any income you get from the state pension – which is more convenient.  

So if you have access to an auto-enrolment pensions, I'd usually look to at first try to max it out so you get the biggest employer contribution 'pay rise' and tax relief. Of course the best option between property and pension is to try and balance both – never easy.

For those asking about investment properties (rather than the home you live in) versus pensions, then it gets really complex and isn't really my expertise – especially as the answer would often require a crystal ball. 

In general though, a pension is generally more tax-efficient and has the employer contribution (and, as mentioned, you could choose investments where the underlying returns are based on the property market), but owning a house is something you can often put your own work into, and if you get it right, that may enable you to get quick growth. There's no right answer (and there is only a wrong answer with hindsight).

Q. My company says I can get even more via salary sacrifice?

A. This is where you give up monthly earnings, say £1,000, and ask for your employer to contribute it to your pension instead. This gains you and your employer reduced national insurance contributions, which means you get more in your pension.

So if we look at the example above, instead of it costing £80, it could actually only cost you £68 to put £100 in your pension (including the employer's contribution).

In some cases, a generous employer will add the gains it's made from national insurance into your pension too, adding even more.

However, it's worth remembering that technically this 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 and employment and support allowance. 

Q. Is there anyone who should be opting out?

A. If you really can't afford to contribute to your pension, you've a right to opt out. Think carefully before you do though – 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 a high 40% overdraft interest. Here it's likely worth clearing these before you start to contribute to your pension. See our Debt Help guide.

  • 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. Use our 10-minute benefit check-up tool.

  • If you already have a pension, especially if it's a very large one, then there is a risk auto-enrolment will put you over the lifetime allowance, which is currently £1,073,100 (though in the Spring 2023 Budget, the Chancellor announced this will be abolished from April 2024). 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.

Q. Isn't a LISA a better way to save for retirement?

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, 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 as about the same gain as putting money in a pension pre-tax for a basic-rate taxpayer, and worse than that 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. When I published the first incarnation of this blog, I was surprised at some of the comments, which were akin to: "I won't contribute because what happens if the firm loses money, like what happened with BHS, then reduces the pension payout?"

I hadn't included that in the article as 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 and I'd love to know your thoughts below, especially if this has spurred you to take action on your pension.