Your Workplace Pension

Things are changing…

From October 2012, the way in which occupational pensions operate is changing. Employees will be automatically enrolled into a workplace pension, many of which will be a NEST pension (the National Employment Savings Trust: set up specifically for this purpose). The employee will be able to opt out of the workplace pension, but every three years will be automatically enrolled again. This is a gradual change that will be phase in over a period of six years, beginning with the larger companies first.

Why is this change being made?

The government has recognised for some time now that the payment of state pensions and benefits in retirement is unsustainable. As the demographics of the UK’s population is changing, with a growing number of older people being supported by the taxes of a decreasing number of younger workers, the payment of state pensions is becoming increasingly difficult to maintain. This is the so-called ‘pensions timebomb’.

Successive governments have tried to address this situation by giving pension investment tax advantages, but still private pension provision in the UK is a long way from being adequate. Making some private pension provision statutory is the next step, and the logical way to achieve this is through the workplace.

How much will it cost?

For many people, the choice of whether to remain enrolled will be firstly dictated by the cost of doing so. The employer will tell the employee how much will be deducted from the monthly pay packet, but there are minimum amounts set by the government and these amounts will rise over time.

Between October 2012 and September 2017, for those opting to remain in the workplace pension the contribution will be 2% of salary. Of this amount, the employer must contribute at least 1% with the employee paying in 0.8%. Just like any other pension scheme, the government will top up the employee contribution with a tax ‘credit’ of 20%: if the employee pays 0.8%, the government will pay 0.2% by way of tax relief.

For the next year, from October 2017 to September 2018, the total contribution rises to 5% with the employer contribution 2.4% (and the government’s tax credit at 0.6%). The employer will be required to pay in a minimum of 2%.

After this time, the total contribution will rise to 8%. However, the employee will only pay half of this, with the employer contributing a minimum of 3% and the government’s tax credit being 1%.

But it’s not payable on your entire salary

The workplace pensions payments, employer and employee contributions, only become payable after a minimum amount of earnings. Initially this will be set at £5,564. They will also only be payable up to an upper limit (starting out at £42,475).

However, they will be based on all earnings including bonuses, commissions, and overtime.

For example, in the first year, for an employee earning a gross amount of £20,000 the pension payments will be based on earnings of £14,436 (£20,000 – £5,564). The employee contribution will be £115.49, or just £9.62 per month. The payment into the employee’s workplace pension scheme, however, will be £288.72 or £24.06 per month.

How is the money invested?

Like many pension schemes, there will be a choice of funds for the employee to select for his pension investments including a default fund. NEST pensions will offer a choice of six funds. The default fund will operate like a lifestyle fund, by investing in higher risk investments when the employee is younger, and cutting that risk as the employee moves toward retirement in order to protect the fund value and potential benefits in retirement. Other funds available cater to different investment styles and attitudes to risk.

NEST pensions will incur costs within the fund, just like all other pension schemes. The costs will be 0.3% annually on the total fund value, and 1.8% on new contributions.

What if I leave my employer?

Workplace pensions will be able to be transferred to the workplace pension scheme of a new employer providing the rules of the new scheme allows a transfer in. NEST pensions, however, will have restrictions placed on them as regards transferring into non-NEST schemes. In such a case, the workplace pension will be frozen, with benefits taken at the time of retirement.

Is it worth it?

For many people, a workplace pension will be the first pension investment they make. With the level of employer contributions and the tax paid by the governments on the scheme, it will also be one of the most financially advantageous investments made, too.

Consider the above example, of an employee earning £20,000 per year. If all the rules remained the same (contributions, tax, and lower and upper earnings limits) and the employee’s earnings remained the same throughout a period of 40 years, then the employee would have invested £19,632.96 into his workplace pension.

But consider how much the total contributions will be. Including the tax credit and employer’s contributions, but excluding fund charges, the total amount paid into the scheme will be £41,431.32.

In summary

By being enrolled in a workplace pension, the amount of money you put into the scheme will be more than doubled by employer contributions and the tax relief. You will be saving for the long term, and be less reliant on the decreasing benefits offered by the state pension and welfare system in retirement. You can, of course, still invest in other pension schemes, but a workplace pension is one that is hard to resist on the grounds of financials and long term wellbeing.

Bob Dylan – Time Times They are Changin’

httpv://www.youtube.com/watch?v=U7VvhHPS67E