For years successive governments have realised that so many people were contributing little or nothing towards their pension. This meant that far too many were relying on the state pension which is unlikely to maintain their same lifestyle.
Currently, the state pension is only £168.60 a week (£8,767.20pa). To boost retirement income, an auto-enrolment scheme has been introduced.
All employers are required to enrol staff in a workplace pension scheme once they are aged 22 years but below the state pension age and annually earn over £10,000 in the 2019/2020 tax year.
Employees outside these restrictions – such as someone earning £6,136-£9,999pa – are not automatically signed up for the workplace pension but have the right to opt in and, if they choose to do so, their employer must contribute. Those earning below £6,136 can ask to join but the company is not obliged to pay in.
Putting money away for retirement may be an otiose act for youngsters but should be a priority for those aged over 30 years. Yet, as an indication of inertia and lack of knowledge, an amazing 82 per cent of the nation’s savings is invested in easy-access accounts, worth £757bn, and paying a derisory 0.54 per cent.
With inflation running at 2.1 per cent, as measured by the Retail Prices Index, this means that the value of such savings is being eroded.
Now that pensions are being actively encouraged by employers, over 10m people have either started saving into a workplace scheme or have increased their contributions.
“This is fantastic news as it means that considerably more people will be better prepared for their financial futures,” says Andrew Nelson, corporate consultant for Chase de Vere, part of the Swiss Life Group.
Auto-enrolment started to be phased in from October 2012. Employers are required to pay in a minimum level to their staff pension plan. Whilst there are contribution thresholds, firms may well choose to be more generous as a good incentive to join or stay with the company even though it is an added financial burden, particularly for small businesses.
A firm’s contribution must be at least three per cent of qualifying earnings up to £50,000 pa. This includes salary, overtime, commission and bonuses, as well as statutory sick pay and any payment during maternity, paternity or other kind of family leave.
If the employer pays the minimum required, then the employee has to contribute at least five per cent so that the total minimum is eight per cent, which is up from five per cent since April. The scheme started with just one per cent on each side. When a firm pays in more than the minimum, the staff contribution falls.
By comparison, employers pay 9.5 per cent staff gross earnings in Australia and this ratio is anticipated to rise to 12 per cent by 2025.
Saving through a pension is incredibly tax efficient as initial tax relief is given on contributions, pensions enjoy tax-free growth and, when taking benefits, you can receive 25 per cent of the value tax-free.
Whilst an overall eight per cent annual contribution is helpful, financial advisers say it is still short of the amount required to secure a comfortable standard of living in retirement.
Royal London calculates a pension pot of at least £300,000 should be built up, which equates to £113,400 contribution between the ages of 26-67 years.
Employees do not have a choice of pension provider or scheme but, at the employer’s discretion, may alternatively be able to pay into another plan if, for example, they already have a self-employed personal pension (SIPP) running. In the latter case, the employee can opt out of the auto-enrolled scheme.
The pension schemes set up for auto-enrolment are usually good value and members will have the helpful premium enhancement from their employer.
The Pension Regulator is responsible for ensuring that employers abide by their duties. Firms are free to select any qualifying pension scheme and provider. To assist, the regulator has issued guidance notes as to those which are of good quality and:
Offer pension schemes which are easy to understand
Provide suitable alternative options including a default strategy for those who do not make their own investment choices
Confirm they have the requisite skills and experience.
Even small firms who have little pension experience should find the guidance helpful. Member communications should be regular and in clear English, avoiding financial jargon, and must represent value for money.
The company secretary, human resources officer or whoever else is to make the decision on provider and scheme might care to compare the past performance by insurers. Taking a typical 20-year term, the accompanying table is very revealing.
It shows that a unit-linked basis has proved better on average than a with-profits one. The latter basis of course depends on the whim of the consulting actuary as to how far pension payments will be massaged and how much of the final investment pot will be allocated as a terminal bonus. It is a casino decision.
The clearer alternative is to take a stock-market related scheme, known as unit-linked, which has none of the secret formulas of insurers but will depend on the skills of the fund managers.
There is also the factor of volatility for those who regard stock markets as risky. Staff contributing through auto-enrolment can see the value of their units at any time whilst those in a with-profits plan have no idea how much ‘excess’ profit has been held back and will later be added when the retirement stage is reached.
Anyone selecting the pension provider needs to ask where the money will be invested – avoiding anything other than a low allocation in fixed interest and opting for growth equities instead – and require past performance evidence.
After allowing for an annual 0.75 per cent management fee, many of the so-called ‘master trusts’ registered with the regulator have poor results. Creative Pension Trust, Hargreaves Lansdown and Standard Life are some of the most disappointing. Scottish Widows and TPT are far more encouraging.
Those who opt out of a workplace pension – possibly because they feel they are too close to retirement or find the whole subject too complex – will have a higher sum to take home but are likely to pay more tax. They will not have the benefits of saving or the additional help from their employer.
One risk is that those who have been auto-enrolled may consider that the pension created will be sufficient. This is to adopt a false sense of security. Nelson suggests that the right annual contribution level is 12-15 per cent.
Changes in employment trends mean that people change jobs far more frequently than previous generations. Jason Hollands, of Tilney Investment, predicts how this will affect retirement savings.
He says, it “will mean people collect a mishmash of auto-enrolled, small to medium-sized workplace pensions, so the case for rolling these up and consolidating them in a SIPP is going to grow”.
Conal Gregory is AIC Regional Journalist of the Year.