Under current auto-enrolment rules, total pension contributions must be 5%, with employers contributing a minimum of 2%, with employees contributing the remaining amount of 3% into their pensions. When the new 2019/20 tax year begins on April 6, these contributions will go up to 3% and 5% respectively. In an ideal world, employers would contribute the total minimum needed under auto enrolment rules, but in most cases will pay in the minimum, with the employee needing to pay the rest.
Here, we look at the impact these changes are likely to have on your pay packet, and why you can’t afford to ignore your pension.
Won’t bigger pension contributions mean there’ll be a lot less going into my wage packet?
Don’t worry, most workers won’t see a dramatic reduction in their take home pay once higher pension contributions are introduced.
According to the Money Advice Service’s workplace pension contribution calculator, someone earning £20,000 would see their monthly pension contributions increase from £50 (which includes £10 tax relief) to £83.33 from April (including £16.67 tax relief), meaning £26.66 less in their pay packet each month once tax relief is stripped out.
How do I work out how much I'll have to pay?
You can check exactly how much will be paid into your pension by you and your employer using the Money Advice Service’s workplace pension contribution calculator.
It’s important to note that the above example is based on pension contributions being deducted from total pay. In fact, contributions are usually based on a set band of earnings, known as your “qualifying earnings”.
Your qualifying earnings are the amount between £6,032 and £46,350 in the 2018/19 tax year, so the first £6,032 of your salary isn’t included when employers work out your contributions. These limits will change to £6,136 and £50,000 in April once the new tax year begins. For example, if your salary is £20,000 in the 2019/20 tax year, your contributions would only apply to £13,864 of your salary, i.e. the difference between £6,136 and £20,000.
Not sure I like the sound of handing over more of my pay. Is it worth opting out of auto-enrolment?
It might be tempting to opt out of auto-enrolment due to the increases, but you’ll need to think very carefully about the long-term consequences of doing so.
Michelle Gribbin, chief investment officer at Profile Pensions said: “People often think that they will start to save into their pension a few years on, maybe when they feel they have some money to spare, but the truth is people forget and push it to one side, and the longer term benefits really outweigh the short term impact.”
So what are the benefits of sticking to my pension?
One of the biggest advantages of rising auto-enrolment contributions is that your employer will also have to pay more into your pension, which means you’ll end up with more in your pension pot at retirement.
Don’t forget too that you’ll get tax relief on anything you and your employer pay in, so the more you both contribute, the more you’ll get back from the taxman. If you’re a basic rate taxpayer, a £100 contribution into your pension will only cost you £80, or if you’re a higher or additional rate taxpayer the same contribution will set you back just £60 or £55.
“These contributions, which may seem small at first, invested in the right way, could lead to thousands of pounds in retirement which could make the difference between a very modest retirement and a comfortable one,” said Mrs Gribbin.
For example, 8% annual pension contributions from the age of 30 on an average annual income of £28,677 could mean £125,000 in your pension pot at retirement. This assumes retirement at 67 and an annual investment fund growth of 3%, with 1% annual management charges. However, bear in mind that this is only an illustration and investments will not grow at a set rate each year, the value will go down as well as up.
Sounds good! If I stay opted in can I just forget about my pension and then reap the rewards when I retire?
No, you can’t - it’s really important to keep a close eye on your retirement savings, how they’re invested and how much you’re paying in charges.
If you just ignore your pension, there’s a chance your money could be going to investments which don’t perform as well as others that might be available to you. Similarly, charges can have a significant impact on the amount you end up with at retirement, so you need to make sure you wouldn’t be better off transferring to a cheaper provider. You can read more about why charges matter in our blog Check your charges.
Remember too that if you decide to move employers in future, your pension scheme is portable, so you may decide you want to consolidate your retirement savings into just the one plan to make them easier to keep track of. Seek professional financial advice before transferring your pension to make sure this is the right decision for you.