If you’re in a company pension scheme, you might notice your pay packet is slightly smaller this month. Believe it or not, this is a Good Thing. The reason is that the percentage deducted for your pension has increased. Your employer is also required to contribute more. This means you’re effectively getting a pay rise, albeit one that you won’t see till you’re at least 55.
In this post, I’ll outline how auto-enrolment works and what it costs you. I’ll also explain why it could make sense to increase your contribution even further.
What is Auto-Enrolment?
Launched in 2012, auto-enrolment is a Government initiative designed to help people save for retirement through a work-based pension. It’s compulsory for employers to enrol any eligible workers1 in the scheme. Both employer and employee make minimum contributions (and can opt to add more).
How much do I and my employer contribute?
The minimum percentages have been climbing over the last couple of years. From 6th April 2019, they are as follows:
- Your employer contributes 3% of your qualifying earnings
- You contribute 5% of your qualifying earnings
This makes a total of 8%. Sounds like a lot, doesn’t it? Hold on. Those contributions are based on your qualifying earnings, which is not the same as your salary. Qualifying earnings are those that fall within the National Insurance (NI) band of £6,136 – £50,000. This means you get no pension contributions on the first £6,136 of your salary or beyond £50,000.2
Let’s look at an illustration.
Say you earn a pensionable salary of £24,000. Your qualifying earnings are £17,864 (£24,000 minus £6,136). The contributions are as follows:
|Employer||£535.92 per year||£44.66 per month|
|Employee (includes tax relief)||£893.20 per year||£74.43 per month|
|Total||£1429.12 per year||£119.09 per month|
Your contribution is made from your gross (pre-tax) earnings, so you receive tax relief on this amount. In short, it’s worth more than if you received it in your pay packet. You still receive tax relief even if you don’t pay tax. In this case, the Government adds £2 for every £8 you contribute.
Higher- and additional-rate taxpayers are entitled to additional tax relief. Some firms apply this automatically, but often you’ll have to claim it through your tax return. Check with your payroll department.
Is auto-enrolment enough?
This depends on how much is going into your pension pot and what you’ll need at retirement. You can use this calculator from the Money Advice Service to work out the figures based on your salary. You’ll need to check what your employer is contributing to get an accurate calculation. They may have chosen to give more than the minimum.
Next, try the retirement income calculator. Here you can see the total value of all your pension pots, along with the state pension. This’ll give you projected retirement income. If it’s not enough, you might need to consider increasing your contributions. Play with the calculator to see the effect of paying more.
You could also look at other ways of building your retirement income. The sooner you start, the more time your pot has to grow.
Most calculators assume that you’ll need around two-thirds of your salary during retirement. As I explained in an earlier post, this isn’t always a good benchmark.
For more scenarios and FAQs, read the MoneySavingExpert guide on auto-enrolment.
Can I opt out?
Yes, at any time. If you opt out within one month of enrolment, any contributions you’ve made are refunded. After this time, you can normally only access the funds when you reach the minimum retirement age (currently 55).
If you decide to opt out, your employer is legally required to re-enrol you every three years (assuming you still meet the eligibility criteria). You’d then need to opt out again if you don’t want to be in the scheme. Think carefully before opting out. Do you have alternative provision for retirement? After all, it’s unlikely you’ll be able to live on the state pension.
It’s good that the Government has made it easier to save for retirement. However, we still need to check that auto-enrolment is serving its intended purpose. Given contributions are based on just part of our salary, those contributions might not be sufficient. For instance, if you earn around £12,000pa, contributions are paid on only half your salary. Please do check that you’re on track to build a decent pension pot.
For many people, though, auto-enrolment offers significant advantages – everything is managed for you, your employer makes contributions, and you receive tax relief. And recent tax changes mean you might not even notice your increased contribution this month.
Make sure you understand what’s right for you. It’s much easier to fix now than when you’re 68.