Posted on January 3rd, 2014 | Categories - Automatic Enrolment
Your employer might already offer you a pension, if this is the case then good for you, making provision for your retirement has never been more important. But, if you are one of the millions of workers not currently in a workplace pension, you are over the age of 22 (at the time of enrolment) and earn more than £9,440 per year (the figure for 2013/14 – £10,000 in 2014/15), you will be automatically enrolled into a scheme between now and 2018.
This means both you and your employer will start putting money aside for your retirement. The exact date when you will be enrolled will depend on the size of your employer; larger businesses will have to set up pensions earlier than smaller employers.
Good, but not perfect
We firmly believe Automatic Enrolment is a good thing, it will encourage more people to save for their retirement and the contributions will usually be split between the employee and the employer.
But, the system isn’t perfect.
One of the main problems is likely to be a sense of complacency amongst employees. A worker being automatically enrolled into a pension could mistakenly think that’s all they need to do to provide a large enough income in retirement; frankly, anyone who believes this is wrong and here’s why.
Firstly, the minimum contribution levels start at just 1% from the employer which, if the employer pays at the minimum level, would mean a minimum of 1% from the employee, rising to a maximum required contribution level of 8% in 2018, of which the employer must pay at least 3%.
8% of salary might sound a lot (imagine if you got that as a pay rise right now!) but it is below what most experts suggest is the minimum people should be paying into their pension.
Secondly, due to the complex Automatic Enrolment rules it isn’t 8% of salary, but a potentially much lower figure. When you are automatically enrolled, if your employer is operating on a ‘qualifying earnings’ basis, your contributions are based on a band of your earnings between a lower and upper level, £5,668 and £41,450 in the current tax-year.
This means that if you earn the average UK salary of £23,296 per year (Source: Office of National Statistics ), your contributions may only be based on £17,628 for the current tax-year; so not only may you not be paying enough, the percentage which you are paying may not be of all your salary.
For higher earners the situation is even worse. Take an employee earning £60,000 per year, their pension contributions will be based on £35,782 if a qualifying earnings definition is used, when in actual fact they earn, and no doubt spend, significantly more.
“How much will my Automatic Enrolment pension pay me?”
That really is the $64,000 question.
The answer is that it’s different for everyone and depends on a number of factors including:
- The age you start paying in; the sooner the better
- The age you retire; the longer you leave it the bigger your pension should be
- The amount you pay in; the more the better!
- The growth you achieve; higher growth will give you a larger pension pot than lower growth will, not rocket science is it?
- The charges you pay; the less you pay in charges the more you will have in your pot when you retire, again, all pretty obvious
But, to give you some examples, we’ve crunched the numbers for different ages based on an average UK salary of £23,000 and contributions which rise in line with Automatic Enrolment rules. We’ve assumed you get growth of 5% each year after charges. We’ve used today’s Annuity rates, which could of course change, to calculate the income you might get and assumed it will stay level in retirement and pay 50% to your spouse should you die before they do.
|Pension fund at retirement age||£150,000||£80,459||£38,059||£13,752|
|Income in retirement in today's money||£8,416 per year||£4,505 per year||£2,131 per year||£770 per year|
|Income in retirement assuming 2.5% inflation||£3,127 per year||£2,143 per year||£1,297 per year||£1,661 per year|
Of course you will get your State Pension too, but can you really afford to live on the income Automatic Enrolment will give you when you retire?
Is an income of between £1,661 and £3,127 per year really enough to live on?
“Definitely not. So how can I increase my income in retirement?”
Assuming you don’t think Automatic Enrolment, plus the State Pension, which remember you might only get well past your 65th birthday, isn’t enough, then how can you increase your income in retirement?
Here are three options:
1. Pay more in to a pension We know this might not be easy right now and it sounds obvious, but it really is the easiest way of you increasing your income when you retire. Just because the Automatic Enrolment rules say total contributions must start at a minimum of 2% and rise to a minimum of 8% by 2018, there’s nothing to say you can’t pay more in.
As an alternative, you could take out a separate pension for your additional contributions.
2. Use alternatives Planning for retirement isn’t just about pensions, yes, you get tax-relief on contributions but there are downsides too. Saving into an ISA (Individual Savings Account) can provide flexibility and a tax-free income when you retire and there are other options too for the more adventurous investor, such as a buy to let property.
3. Delay your retirement The longer you wait until you retire the bigger your pension pot should be. Our figures show projections to age 65, for most people their State Pension age will be later. Working up until your State Pension age might make retirement more comfortable, not only will you have the income from the state, but you will have given your own pension pot longer to grow and will have paid more in.
Start at the beginning
The starting point for any retirement planning is to think about when you want to retire and what income you’ll need. Only then can you calculate the amount you need to contribute and whether it’s affordable.