What are the most important things to know about auto enrolment? How you can get a pay-rise just for paying into a pension? Read on and find out more.
What’s it All About?
The Simple Answer
Auto enrolment is a government scheme set up to help more people pay into a pension through contributions from you, your employer and some tax relief.
The Detailed Answer
If you meet certain criteria, which I will go into later, you will automatically be placed into a workplace pension and expected to start contributing to it.
Prior to its introduction in 2012 it was the employee’s decision to join a pension scheme. The problem with that was that you had to know how, when, what, why, where’s my cat etc. The previous set up didn’t work too well, and many people didn’t consider saving for retirement – big problem. This was probably due to the relatively complicated nature of pensions and that most people just don’t think about retirement until it starts knocking on the door.
Jump forward several years and as of 2019 over 10 million people have been auto enrolled. What a success! 10 million people are now saving for a better retirement.
How Does it Work?
You pay a percentage of your salary every month in to a pension, your employer also pays a percentage every month, and so will the government.
In order to be automatically enrolled you have to:
- Be employed (or classed as a worker)
- Aged between 22 and State pension age (Click here to find out your state pension age)
- Earn at least £10,000 per year.
- Work in the UK
If you meet the above criteria then your employer will automatically enrol you into a workplace pension.
Unless you opt out, which you can do so if you wish, the monthly deductions will start showing on your payslip.
How much will be paid in?
Would you like a pay rise?
The minimum that has to be paid in is 8% of your qualifying earnings per year (before tax). At least 3% of the 8% has to come from your employer, leaving the remaining 5% to come from you. If you’re lucky and have a nice employer who would like to go above and beyond, then they can pay in more than 3%.
Should your employer decide to pay anything more than 3% then you just have to make up the difference to bring it to 8%. You can also contribute more if you like.
The 8% will be applied on your earned income before tax between £6,240 and £50,270 per year, it isn’t applied on income less than the £6,240 minimum threshold.
Here’s what it would look like if you earned 30K a year:
= £30,000 salary – £6,240 minimum threshold.
= £23,760 * 3% = £712.80 from employer.
= £23,760 * 5% = £1,188 from you.
= 8% or £1,900.80 per year in total.
The same maths applies to £50,270 (the top end of the scale).
= £50,270 – £6,240 = £44,030 *8% = £3,522.40
£50,270 is the ceiling, if you earn any more than this the total applied will still only be a maximum of £3,522.40.
You might be wondering why the requirements are 10k but there is a minimum threshold of £6,240. This is simply because you will be automatically enrolled if you earn £10,000 or more, but you’re not automatically enrolled if you earn less than £10,000. You could opt in yourself without auto enrolment if you earn between £6,240 and £10,000.
Tax relief
Earlier I mentioned that the government will also pay into your pension, this is in the form of tax relief.
The government refund back the tax that you have already paid on your income, that is 20%, 40% or 45%.
If you’re a 20% tax payer, then life is easy. The 20% tax that you’ve paid gets automatically added back into the pension and there’s nothing else you need to do.
If you’re a 40% or 45% tax payer, then you will get the 20% tax relief added automatically, but most places will require you to claim back the remaining 20% or 25% via a self-assessment tax return.
Example:
If you want £100 contributed to a pension then you would put in £80 as a basic rate tax payer and you would receive tax relief of 20% or £20 form the government.
The same rule applies for a 40% & 45% tax payer – You would put £60 and £55 respectively into the pension and claim tax relief of the remaining £40 & £45.
This can make a huge difference in your savings over the years.
As a basic rate tax payer, based on the example above, you would have contributed £960 over the year and the government £240 which is 25% of the £960.
At 40% and 45% you would have paid £720 & £660 respectively and the government would have paid £480 & £540. That’s a whopping 67% and 82% of the amount you put in.
Total amount contributed
If your salary is £30,000, your total pension contributions would like this:
Your contribution of 5% each month = £79.20
Work 3% contribution each month = £59.40
Government tax relief contribution each month – £19.80
Add the government and work contributions and you double your contribution.
£59.40 + £19.80 = £79.20.
Congratulations, you’ve received a pay rise for saving your own money in to a pension.
Can I opt out?
The short answer is, yes you can.
If you do opt out then you will lose the tax relief and the contribution work provide.
But there are a few good reasons to opt out:
You can’t access the pension until retirement, so you might opt out if you need your money sooner.
If you have debts to pay and would like to use your contribution towards paying them off.
If you have reached the lifetime allowance (currently £1,073,100, 2021/2022) via other pension plans you have. If so, auto enrolment could have some serious consequences, so please consult an Independent Financial Advisor.
Should I pay more than required?
This is a much broader question than you may think.
First of all,
Maximise your contribution level
Some employers will pay more than their required 3% if you pay in more than your required 5%.
Example:
Joe Blogs Industries will pay in to your pension 5% of your salary on the condition you pay in 7%.
Joe Blogs Industries is paying an extra 2% of your salary. Go Joe!
If this is the case then please take them up on the offer, as long as you can afford to do so. These additional payments can be very valuable, and again provide you a bigger pay rise.
Pension Investments
Normally you would not be able to choose the pension provider that the payments are made to, this decision is made by your employer.
The contributions that you make are automatically invested. Often these go into something called a lifestyle fund which will automatically switch you into funds that have a lower risk the closer you get to retirement.
These are a good option and often require very minimal involvement.
The pension providers will also have a range of investment options to choose from should you want a bit more involvement.
If you’re happy with this, stop here, and go to the next section. If you would like even more involvement then read on.
Some pension providers investment choices are limited. This could mean that your money could be better invested elsewhere.
Should that be the case you could consider transferring the money built up each year to a private pension with more investment choice. You would have to make sure the workplace pension is kept open with a nominal figure to allow the monthly contributions to be deposited.
If transferred, you could then manage your own investments as you would in a Stocks & Shares ISA. Have a look through my investing section for ways to manage your own investments. Make sure you know what you are doing with this though, it could be worth contacting an Independent Financial Advisor if your investment options are limited.
Some pension providers may not allow you to transfer partial amounts to another pension provider, if so then this option wouldn’t work for you.
Changing jobs?
Lastly, what happens when you change your job?
Your existing employer will stop their contributions into the pension.
Your new employer will start making contributions instead, should you still meet the eligibility criteria.
The new contributions will likely to be into a new pension contract and not your existing one with your previous job.
The old pension can then either be transferred to the new one, transferred to a private one, or left where it is.
