Auto-enrolment's benefits and the dangers of opting out

Our figures show how auto-enrolment can build a substantial pension pot. Find out what you could accrue.

From 6 April 2019, contribution rates associated with auto-enrolled pensions will rise from 3% employee and 2% employer, to 5% employee and 3% employer.

The new auto-enrolment increases mean that workers with an annual salary of £20,000 would accrue £1,600 a year into their pension, up from the current level of £1,000.

interactive investor has calculated that the benefits of staying in are considerable and amount to tens of thousands of pounds over a working life. 

The investment platform has also calculated the dangers of delaying auto-enrolment by a decade and the figures ring some alarm bells, potentially leaving consumers with a pension pot half the size it could have been at retirement.

Benefits of staying in

A 30 year old with a starting salary of £20,000, increasing by 1% each year until retirement at age 67, would be tens of thousands of pounds better off at retirement after April's increases. A combined employer/employee increase from 5% to 8% could make a difference of over £70,000 from age 30 – 67, assuming an annual average return of 5% per annum. These assumed annual returns are by no means a given, and are for illustrative purposes. With a 7% per annum return, the difference is over £110,000.

£20,000 starting salary: Start age 30, retirement age 67

These figures are calculated in terms of current price levels, ie based on a starting salary of £20,000, which increases by 1% per annum in real terms. 

Rebecca O'Keeffe, Head of investment, interactive investor says: “Although it may be difficult to find that little bit extra to put in your pension pot every month, these figures suggest it will be worth it – and the huge downside in not contributing is that you give up your employer contributions and tax relief too.  

"Based on a salary of £20,000 – you contribute £800, the government tax-relief is worth £200 and your employer would invest a minimum of £600. Opting out means you would lose £800 a year, while staying in at the new minimum levels means that, for every pound you invest, the tax relief and employer contributions immediately double this investment."

4 good reasons for staying in:

• After many years of stagnation, real wages are now increasing at a rate of over 1% per annum.  
• Personal tax allowances are rising steadily, boosting take-home pay.  
• Opting out means that you give up benefits of employer contributions and government tax relief. 
• Perhaps most important of all, the long-term benefits of investing in a pension are potentially very attractive, even for those currently earning less than the median wage.

Moira O'Neill, Head of Personal Finance, interactive investor says: "The new higher auto-enrolment rates mean that someone earning £20,000 would invest £800 a year into their pension, up from £480 currently. For example, a 30 year old earing £20,000 would have to find an extra £320 a year, but that would contribute to a potentially significant pension pot, which could grow to more than £200,000 in current money terms."

Benefits of starting early

Albert Einstein reportedly called compound interest the 8th wonder of the world, and Warren Buffet admitted that "my wealth comes from a combination of living in America, some lucky genes, and compound interest".

Figures from interactive investor illustrate just why compound interest can be so powerful. With a £20,000 starting salary, increasing by 1% each year until retirement at age 67, with 8% pension contributions, and generating a 5% return per annum, a consumer starting their pension at age 20 would have almost £151,000 more than if they had delayed by a decade. 

Likewise, someone starting at age 40 could have £90,821 less in their pension than if they had started at 30.

If you can achieve a 7% annual return on your savings, an extra 10 years of investing during your twenties more than doubles the eventual value of the pot. The younger you start, the bigger the benefits.  

£20,000 starting salary: Retirement age 67, with an 8% pension contribution

These figures are calculated in terms of current price levels, ie based on a starting salary of £20,000, which increases by 1% per annum in real terms. 

These assumed annual returns are by no means a given, and are for illustrative purposes.

Rebecca O'Keeffe, Head of investment, interactive investor says: "Between 2012 and 2017, the best performing auto-enrolment default funds delivered double digit annual returns.  While these rates may be flattered by a weak pound and a global equity bull market, they offer some confidence that the low-cost investment products approved for these types of pension can deliver solid returns for those people who are prepared to put their trust in auto-enrolment pensions."

Moira O’Neill, Head of Personal Finance, interactive investor says: "Auto-enrolment has been a huge success so far, but there is still some concern that the amounts being saved are not high enough. The figures above show that starting as early as possible makes a huge difference to your final pension pot. And if employees can afford to make extra contributions – especially in situations where their employer is also prepared to contribute more - that could transform your retirement plans."

£15.2 billion in auto-enrolment contributions per annum

The overall contribution of auto-enrolment to UK pension savings is potentially very significant.  Based on an average salary for those in auto-enrolment of £20,000 and the current estimates of 9.5 million people investing through auto-enrolment, the increases in April could mean that over £15bn will be invested every year – up from £9.5bn in 2018/19. While this will not all make its way into the UK stock market, it is likely to provide a regular stream of money coming into the market – which has potentially large benefits for both the workers and the companies in which they are employed.