Auto-enrolment pension: what it means for you
Filed under: Pensions
From the 1st October up to nine million employees will start being automatically enrolled into a pension scheme that will be linked to investments, such as shares, unless they choose to opt out. If you're one of them, your pay-packet will fall as you contribute to the pension, which is also paid into by your employer.
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Why is this happening?
The programme, called NEST (National Employment Savings Trust), is to get us to start taking more responsibility for saving for our retirement. The idea is to make 11 million future retirees, who aren't saving enough, less reliant on taxpayers and the largess of Government.
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Taxpayers – especially future generations of taxpayers – gain by the same token, because they will need to pay less in benefits to retirees in decades to come, merely to give their parents and grandparents a basic standard of living.
Who will this affect?
You'll be automatically enrolled if you're at least 22 but under State Pension age and if you're earning more than £8,105.
When is this happening?
Employees will be auto-enrolled over the next few years, depending on the size of their employer.
The first wave of people will join schemes inside two weeks and the Government expects that 600,000 will be paying contributions into it by the end of the year. By 2015, it expects more than four million to be in the scheme, and the roll out will be finished by 2018.
The schedule is:
How much will my salary fall?
You can pay in extra in regular amounts or one-off contributions, but your employer will contribute out of its own pocket too.
Minimum contributions include payments from your employer, Government and yourself, and are based on your pre-tax earnings, excluding the first £5,564 and up to £42,475. These figures will be reviewed every year.
The minimum contributions will increase between now and 2018 as follows:
In today's prices – which means deducting inflation – here's what you might expect to get from your pot, but please bear in mind these are just rough estimates, since we can't predict the future of your investments:
These aren't huge amounts, but you'd hope that they'll nicely supplement State Benefits, and will mean you're less reliant on them. You and your employer can also contribute extra. Doing so in the earlier years in particular is likely to make a massive difference. Retiring later can also hugely increase your up-front cash and annual income.
What should I watch out for?
Costs, diversity and investment choice are the three main things most people should consider when investing.
NEST will work out at an annual charge of around 0.5% for most people, which is pretty good. Add on trading costs and the overall total will hopefully be less than 1%, which is also quite good.
It is certainly diverse, since your money will probably be invested across a wide range of assets. This will help protect you from a massive disaster in on asset, such as a single company going bust and you have half your money in it.
What can I invest in?
However, investment choice is not so good, and this is the third thing to watch out for. With the default fund – which most people don't bother changing – NEST is looking to be very cautious and to smooth out your progress, meaning no big highs or lows. The problem with this approach is, while it's reassuring in the short-term, you should expect it to mean a worse performance in the long run.
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I have tried to take that into account with my projections in the section above, but I might have underestimated the impact of this smoothing action, depending on how cautious NEST will be. Time will tell.
The closer you are to retirement, the more cautious NEST will be, which makes sense. You can choose a handful of other funds: ethical, Sharia-compliant, higher risk, lower growth and pre-retirement funds. You can swap between funds at no cost, but be wary of jumping ship after a big fall and hundreds of scary news stories. This is almost always the worst time to do so.
Can I move other pensions into it?
At present, you can't transfer pensions into or out of NEST.
When can I take cash out of the plan?
Your money is locked in until the agreed end date, which is usually around your expected retirement date. Under current rules, you can then take 25% of your pot as tax-free cash and normally you'll then get a monthly income from the rest, guaranteed for the rest of your life.
You can only normally get all your money back straight away if you have been auto-enrolled and you opt out within one month of this happening.
Should I opt out?
It's a good idea to take as much control of your financial future as possible and, the earlier you do this, the better.
That said, if you're struggling with debt, it can make sense to put more money to paying that off.
In addition, consider share ISAs instead, due to the risks of Government tinkering with pensions. Governments can tinker with share ISAs too, but it's probably going to be easier to get all your money out of an ISA, if trouble comes.
Lower earners in particular might find that their contributions come to nothing, because it just means your benefits are reduced in retirement. Therefore you might opt out – although this is hard to predict and could turn out to be just as risky as not saving in a pension. The choice is simply not easy.
Will I be opted in again later?
If you opt out, you'll be automatically enrolled every three years unless you opt out again.
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