Will your pension get you the retirement you want? The ultimate guide to auto-enrolment

Here's what you need to know about auto-enrolment to ensure your pension stretches to the retirement you want

Gone are the days when you had to decide whether you wanted, or could afford, to join your workplace pension. If you are aged 22 or over and have a salary of more than £10,000 you will automatically be signed up to your employer’s scheme and pension contributions will be deducted from your earnings every month.

If you don’t want to join it, you don’t have to, but you will have to actively opt out. Since 2012, when so-called auto-enrolment rules were introduced, some 10 million workers have been automatically signed up to their work pension and a further 591,000 have been re-enrolled.

How auto-enrolment works

Under the rules, scheme members pay a minimum of 8% of qualifying earnings into their pension.

This is made up of 3% from your employer, 4% from you, and 1% from the Government in the form of tax relief.

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However, it is important to note that this does not necessarily mean that 8% of your earnings are being paid into the scheme. Minimum contributions are only based on your ‘pensionable’ or ‘qualifying’ earnings, which are currently those between £6,240 and £50,000 a year.

Schemes are designed with inertia in mind. Although they will offer a choice of funds for you to pay your contributions into – investing in different areas, with different objectives and varying levels of risk –if you don’t actively decide where to invest, your money will be paid into a default fund.

Experts agree the scheme has been a huge success so far. More people than ever are putting money away for their retirement, with participation in company schemes now at an all-time high of 87% – up from just 55% in 2012. Crucially, the strongest growth in participation has come from those under 30, more than doubling from 35% in 2012 to 79% today.

In 2012, it was predicted that as many as a third of employees would opt out of the scheme. However, government figures suggest that less than one in 10 has done so.

“Millions of workers have risen to the challenge of automatic enrolment, despite the fact that average real wages have fallen over the past decade,” says Alistair McQueen, head of saving and retirement at Aviva. “For this, Britain’s workers deserve huge credit.”

Five questions to ask about your workplace pension:

1 How much are you paying into your pension and is your contribution based on your total earnings or a band?

2 How much is your employer paying into your pension?

3 If you pay more in, will your employer match your contributions?

4 If you pay higher-rate tax is higher-rate tax relief being paid automatically or do you need to claim it through your tax return?

5 Where are your contributions invested?

Retiring on less than the living wage

However, while participation levels might be high, engagement isn’t, and experts from across the industry are concerned that people are not putting away enough money and are in danger of sleepwalking into a cash-strapped retirement.

McQueen adds: “Automatic enrolment thrives on inertia. By doing nothing, the system has successfully introduced millions of people to retirement saving. But this inertia is matched with low levels of public understanding and confidence in pensions. Less than half of the population – 42% – believe they understand enough about pensions to make decisions. Inertia coupled with uncertainty is a dangerous combination.”

Indeed, research from Aviva has found that millions of workers who are only paying the 8% minimum into their pension over their working life could still find themselves retiring in poverty.

Even someone who started saving at 22 (the age of eligibility for auto-enrolment) with an average salary of £27,456, would only get £12,587 a year when they retire – that’s just 46% of their gross income, and £2,355 below the national living wage (currently £14,942).

This could potentially result in millions of workers retiring angry and disappointed with the size of their workplace pension when they eventually retire.

As Kate Smith, head of pensions at Aegon, says: “The problem is perception. Individuals will think they have saved enough because this is what the government said they should save. But 8%, or indeed 8% of a band of earnings, is not enough.”

How much are you really paying into your pension?

The issue of ‘banded’, ‘qualifying,’ or ‘pensionable’ earnings confuses matters even further.

It’s a jargon minefield and employees can easily be forgiven for thinking that they are contributing more than they are.

This is because actual contributions are only based on earnings between £6,240 and £50,000. Therefore the minimum 8% contribution can only apply to a maximum of £43,760, however much you earn. This can be misleading for both lower and higher earners.

For example, somebody earning £10,000 a year – the trigger income for auto-enrolment – would only receive pension contributions on a smidge over 60% of their salary, reducing their actual contribution rate to just 3%. Higher earners – who will invariably have higher retirement income expectations – may also end up paying in less than they think too if earnings north of £50,000 a year are not factored into their pension contributions.

According to figures from Aegon, someone earning £50,000 would only actually be paying 7% into their pension.

For somebody earning £60,000 that falls to 5.8%, and if you earn £70,000 your contribution rate would be just 5%.

If you earnt £90,000, less than half your earnings would be considered as pensionable and so your real contribution could be as little as 3.9%.

Why you need to check your scheme

Thankfully the 8% figure is just a minimum and many employers will pay more. Some will base contributions on total salary, others will pay a higher rate or match your contributions – so the more you pay in, the more your employer will top it up.

Jonathan Watts-Lay is a director at Wealth at Work, a company that provides financial education and guidance in the workplace. His clients are typically larger employers. “I would struggle to find a client that doesn’t pay more than the minimum. But lots of SMEs will just pay the basic.”

Smith adds: “Employers will do a variety of different things. Some will pay more to be competitive, others will just see the work pension as a compliance exercise.

“For smaller employers and many start-ups the workplace pension won’t be seen as a priority and they may reward their staff in other ways.”

How paying 1% more can transform your retirement

Charlie is 25 and earns £25,000 a year. He plans to retire at age 68. At the moment he pays 5% of his salary into a pension and his employer pays 3% through auto enrolment. It is estimated that his pension will be worth £124,177 when he retires.

If he increased his contribution by 1% to a total 6%, an extra £250 a year would go into his pension. However, this would only cost Charlie £170 because the contribution would be taken before tax and national insurance is deducted. This works out to about £14 a month.

Charlie’s total contribution is now 9%, and his pension is estimated to increase to £139,699 – an increase of £15,522 or 12.5% of the original pot.

If his employer was to match his 1% increase, the total pension contribution would be 10% and the pot would increase to £155,221 – an overall increase of £31,044. 

This is more than 25% increase of the original pot.

(Source: Wealth at Work)

Take action

The most important thing to do is to find out how much money you and your employer are paying into your pension and whether contributions are based on your total earnings or a ‘band’. Smith says: “You will have been given a joiner's pack for your pension when you started and it will be in there. If you have any questions ask HR.”

At the same time, it is also worth finding out if you are getting the correct rate of tax relief on your pension contributions. “If you pay a higher rate of tax you may have to claim some of it back via a tax return,” Smith adds. Basic-rate tax relief is applied automatically but whether or not the further 20% for higher-rate tax payers is will depend on the set-up of the scheme. That is yet another question that your

HR department will be in a position to answer.

If you are only getting minimum contributions, you will need to pay in more yourself. Aviva would like auto-enrolment minimum contributions to be increased to a minimum of 12% of total salary. This would see our average worker, who started paying into a pension at the age of 22, retire with an income of £16,237 – 59% of their working income and £1,295 a year more than the national living wage.

While older workers might feel more motivated to boost their retirement savings, those at the start of their working lives shouldn’t put it off.

“At 22 it is difficult to relate to pensions but the contributions you pay in when you are young are the ones that work hardest over time and really make a difference,” says Fiona Tait, technical director at Intelligent Pensions. “This is particularly important for women who are more likely to take career breaks.”

Typically, women are retiring with 40% less saved in their pensions than men, according to consultancy firm Mercer, so any extra saving that women can do before any family or children complicate matters the better.

Easy ways to boost your pension

Stepping up pension contributions can feel like a wrench – we all have enough calls on our cash as it is. However, there are simple ways to make it less painful.

Tait suggests doing it every time you get a pay rise. “If you link it to increases to your salary you don’t actually miss the extra money,” she suggests. “Also look at it when a regular expense disappears – such as when you pay off a loan or credit card or your childcare bills stop. Put that extra money into your pension before you get used to it.”

Watts-Lay also suggests some simple ways to create some extra cash – allowing you to pay more into your pension without making any material difference to your lifestyle.

“Don’t auto-renew your home or car insurance – shop around for these and your utilities. If you aren’t doing that already you should easily be able to save a few hundred pounds,” he says.

Aside from contributions it can also be worth thinking about where you invest your money. Smith says: “More than 90% of people are in the default fund, even if they actively choose it.”

Views are mixed on how wise this is. “There will be nothing wrong with the default fund,” says Tait, “but it will be aimed at that ‘mythical average investor’ and you are unlikely to be that average person. Most will do what they are designed to do but that’s a least-worst scenario not the best.”

Default funds will be regularly monitored and reviewed but they may be more cautious as a result. Tait adds: “If you are at the younger end of the scale you can ride out stock market risk and can afford to invest more adventurously.”

For Watts-Lay, however, it’s the size of your contributions that is all-important – particularly if investment isn’t your bag and you don’t have the confidence to choose investments yourself. “The margin of difference between funds can be quite small but the difference in retirement income from increased contributions can be huge.”  

The future of auto-enrolment

Although auto enrolment has successfully got 10 million workers saving for retirement, its limitations are widely acknowledged.

Despite two increases to minimum contributions (from an initial 2% to 5% and now 8%), it is recognised that this still may not be enough for a comfortable retirement.

Savings rates should go up at some point in the mid-2020s when the Government scraps the lower threshold for saving (currently £6,240), but no further increases have been planned, with the Government wary of increasing rates by so much that workers will opt out.

It is also considering proposals such as reducing the age of eligibility from 22 to 18 and exploring ways to make the scheme available to the self-employed.