The UK’s most radical reform of workplace pensions starts today, but economists are unclear on its’ overall effect on savings.
Automatic enrolment into a workplace pension, will affect millions of people.
The governments’ aim is to ensure that low and middle earners are provided with a pension additional to the state pension.
For many employees this will be the first time their employer has contributed to their pension.
The pension employees derive from automatic enrolment is designed to complement both the state pension and any private pension saving.
Pensions Minister Steve Webb said: “The huge gap that we are trying to fill is [in] long-term pension saving.”
“We have got half the workforce building up no pension beyond the state pension, and that is why this system is such a positive thing.
“You don’t have all the hassle and complexity of choosing a pension. The firm chooses it for you, they put money in, you put money in, and then the only hassle is if you want to opt out,” he told the BBC.
Under the new scheme, all employees aged over 22 and not currently part of a company scheme will be auto-enrolled into the new scheme.
Auto-Enrolment Criteria
- Workers not currently in a company pension scheme will be enrolled if they are aged between 22 and the state pension age
- Employees must be earning at least £8,105 a year
- The contribution they, and their employers, make will be based on their wage, although the first £5,564 a year they earn will not be taken into account
- Any earnings above £42,475 will also be ignored in the contribution calculation
- So the amount between £5,564 and £42,475 is known as their pensionable pay
- Staff can opt out
Initially this will only amount to a minimum of 0.8% of their pensionable earnings.
By law their employer will, be required to add the equivalent of 1% of their employee’s earnings to the pot. Tax relief adds another 0.2%.
Eventually, these minimum contributions will rise to 4% from the employee, 3% from their employer and 1% in tax relief: a total of 8%.
Payments made into the fund will be invested in either a company’s existing workplace pension scheme, by a scheme run by an insurance company, or by a government-backed scheme, such as the National Employment Savings Trust (Nest).
Upon retirement, usually at the age of 55+ the employee can access the funds to purchase an annuity – an annual pension income for retirement.
Today the largest employers, such as the large supermarkets chains, will be involved in the first wave of automatic enrolment. Other employers will come on-line as the system is rolled out.
The smallest firms will not sign up their staff until June 2015 at the earliest.
How Much Pension?
When the full 8% contribution rate is in effect, someone earning £20,000 a year would see £1,154.88 in combined contributions being added to their pot each year.
A new employee aged 22, who saved for 40 years before retiring at the age of 62, would have contributions totaling £46,160.
If, over those 40 years, there was an average 4% a year return on the funds in which the contributions were invested, then the retiree would end up with a pot of £112,107.
Opting Out
The government says that automatic enrolment is necessary as workers should not rely totally on the state pension when they retire, especially as life expectancy continues to increase.
The policy has been welcomed by a number of campaigners and the insurance industry.
“It cannot be stressed enough how important it is to save for retirement,” said Stephen Gay, of the Association of British Insurers (ABI).
Auto-Enrolment Timetable
- October 2012: Firms with 120,000 employees or more
- November 2012: 50,000 to 119,999 employees
- January 2013: 30,000 to 49,999 employees
- February 2013: 20,000 to 29,999 employees
- March 2013: 10,000 to 19,999 employees
- April 2013: 6,000 to 9,999 employees
- May 2013: 4,100 to 5,999 employees
- June 2013: 4,000 to 4,099 employees
- July 2013: 3,000 to 3,999 employees
- August 2013: 2,000 to 2,999 employees
- September 2013: 1,250 to 1,999 employees
- October 2013: 800 to 1,249 employees
- November 2013: 500 to 799 employees
- From January 2014: Firms with fewer than 500 employees in stages
- From January 2015: Firms with fewer than 58 employees in stages
- February 2018: Timetable completed
Source: The Pensions Regulator
“Automatic enrolment will help workers start a savings habit that will stay with them for a lifetime. The state pension is a foundation, but most people require more and the earlier people start to save, the easier they will find it to build enough savings for their later life.”
Employees will have the option to opt out of the pension savings scheme, and will be given details of how to do this before they are auto-enrolled into a scheme.
“Some people might think about quitting their new pension, but we urge them to stick with it and get saving for their old age,” said Joanne Segars, chief executive of the National Association of Pension Funds (NAPF).
“Leaving the pension would mean losing tax breaks and employer contributions which are, in effect, free money.”
It is hoped auto-enrollment will increase pension saving. Last year, only one in three private sector employees were signed up to a scheme.
The Department for Work and Pensions said that, by the end of the year, about 600,000 more people in the UK would be saving into a workplace pension and by May 2014 about 4.3 million people would be signed up.
The eventual aim is to increase that figure to between six and nine million people by the end of the 2018, by when automatic enrolment will cover all employers.