Youngsters put retirement at risk by quitting workplace pensions

Half a million people a year are now opting out of their workplace pension, according to new data from the Department for Work and Pensions (DWP).

That includes 158,000 eligible workers under the age of 30, equivalent to 9.3%. And it’s a similar story with those aged between 30 and 40, with 9.4% declining the offer of an employer-sponsored pension.

The figures – which are the result of a freedom of information request from business advisory firm Lubbock Fine – highlight a worrying trend, as pension contributions made at the start of your working life stand to have the biggest impact on future retirement finances.

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How workplace pensions work

Pension rules now mean all eligible workers will be “auto enrolled” on to their employer’s workplace pension every time they start a new job.

The minimum contribution is 8% of your qualifying earnings - the range is between £6,240 and £50,270. That’s made up of at least 3% from your employer, with the rest (typically 5%) paid by you and deducted from your salary.

Some employers, however, will pay higher contributions based on your whole salary, not just your qualifying earnings. And, in some cases, they’ll match contributions up to a certain level, meaning the more you’re prepared to save, the bigger the top-up you’ll get from work.

The idea behind auto-enrolment – which has been phased in since 2012 – is that it gets people saving for retirement without them thinking about it.

But employees who don’t want to participate – normally because they don’t think they can afford it – can opt out if they wish.

The risks of opting out

The financial pressures facing younger workers are undisputed, so it’s hardly surprising that hundreds of thousands of this cohort are actively shunning retirement saving.

Student loan changes are making university debts more expensive to repay, while the challenge of buying a property in today’s market can feel insurmountable. Then there’s the rising cost of living and stagnant wage growth which are only compounding the problem.

In fact, in June, the Social Market Foundation went as far as to suggest that younger people should be able to access the first year of their state pension as a lump sum early, to help them rise to some of these challenges.

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However, by prioritising shorter-term financial pressures – and opting out of workplace pensions - younger workers could be inadvertently sabotaging their financial future.

And the gender pension gap means the risk could be even greater for women who opt out.

As women are more likely to take a career break to have children, or move into lower paid part-time work, they tend to have smaller private pensions than men.

According to the Prospect union, the difference between men and women’s pension income is currently a staggering 32.9%.

The ‘magic’ of workplace pensions

When cost pressures are piling up, a pension contribution might look like an easy saving to make, with no immediate impact on your current lifestyle.

But it could take its toll on your future. Over time, the cumulative loss of those contributions will be far greater than the benefit of a short-term monthly saving.

That’s because it’s not just your money going into your retirement pot, you’ll also miss out on your employer’s contribution and tax relief. The latter is an additional pension top-up from the government that effectively rebates the tax that you have paid on those earnings.

As such, when you pay into a workplace pension, you get much more than the actual value of your personal contribution going into your retirement pot.

Here’s how it works:

Take an individual earning £40,000 a year, making the minimum pension contribution (8% of qualifying earnings):

• Personal contribution: £112.54 (4%)
• Tax relief: £28.13 (1%)
• Employer contribution: £84.40 (3%)
• Total amount paid into pension each month: £225.07

In this case, our example gets double their own contribution going into their pension every month.

But some schemes will be more generous.

Let’s say our individual gets contributions based on their whole £40,000 salary, with a double-matched pension contribution from their employer – meaning they get 15% of their salary going into their retirement pot each month.

• Personal contribution (4%): £133.34
• Tax relief (1%): £33.33
• Employer contribution (10%): £333.33
• Total amount paid into pension each month: £500

In this case, the employee’s contribution is more than tripled by tax relief and their employer contribution.

Why early pension contributions work the hardest

The concern around younger workers dropping out of retirement saving isn’t just that they’re missing out on employer and government top-ups.

It’s also that the contributions you make at the start of your career are the hardest working and drive more growth than those you make later on.

So, if you put pension saving on hold until you’re earning more, you’ll miss out on one of the most significant drivers of investment growth – time. And to make up for it, you’ll need to save a lot more.

Albert Einstein is famously said to have described the compounding of returns as “the eighth wonder of the world”. 

As long as you leave your savings or investments where they are and don’t cream off any growth, that money will boost your balance and start earning returns too.

Over time, that can make a significant difference to your investment’s growth. The longer you can leave your money untouched, the more it stands to grow and the less you need to put away.

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So, when it comes to saving for something as significant as your retirement, the sooner you get started the better.

Take the example of someone who starts saving at age 25, with a total of £225 going into their pension each month (including tax relief and their employer contribution). By the time they reach age 67, they will have saved nearly £197,000 themselves and could have a pension worth around £561,000 (assuming 5% investment growth and contributions increasing by 2.5% each year).

But their colleague decides to wait and doesn’t start paying into their workplace pension until they’re 40. Now that they’re earning more, they can afford bigger contributions and are paying a total of £500 a month into their workplace pension. But that’s not enough to make up for lost time and, by age 67, they’ll have paid in over £227,000 and have a pot worth around £446,000.

Prioritising pensions

Whether you’ve opted out already, or are considering a pension break, it’s important to understand what you’re giving up and the effect it could have on your future finances.

For many people there could be other ways to free up money for pensions, so it’s always worth exploring all other money-saving alternatives first – even if they’re more painful in the short term.

Helping adult children

Older parents may also be worrying if they have children at the start of their careers, who are questioning the affordability of their workplace pension.

But helping them out could be a win-win.

With pensions themselves becoming subject to inheritance tax (IHT) from April next year, more wealthier parents are looking to make gifts to adult children to reduce their tax bill.

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That means helping them contribute to their pension could be an incredibly sensible and tax-efficient investment.

You’ll be aiding the process of getting taxable wealth out of your estate, while your children will also be getting the added benefit of tax relief on their pension contribution.

For most gifts, you’ll need to survive seven years for them to become totally IHT free. However, everyone has a £3,000 annual gifting allowance. Or you can give away as much spare income as you like tax-free (helpful for monthly contributions) – so long as you can demonstrate that the gifts weren’t from capital and don’t have a detrimental impact on your own standard of living.