6♣ – Take up your Workplace Pension Offer

This post is part of the MoneyDeck series, a pack of 52 playing cards that describe 52 “golden rules” for Private Investors in the UK.

Take up your Workplace Pension Offer, because it’s Free Money

None of us are getting any younger.

• Sooner or later we’ll all give up work and retire.
• And we’ll need some form of income to live on.

If you want to spend more than the £8K pa that the New State Pension will provide, you’d better get saving.

Today I’m going to try to persuade you to take up the offer of a workplace pension from your employer, because it’s free money.

• This should be easy, but I know from comments on the blog and lots of real-life conversations that many people hate pensions.

There are a few reasons for this:

1. you have to lock your money away for a long time – until at least age 55, and possibly age 60 or later
2. you have to pay tax on the income from your pension
3. lots of schemes are inflexible – they won’t let you invest in what you’d like to
4. there have been a few scandals with bosses dipping their hands into the pension pots
5. returns for many corporate pension schemes have been lack-lustre
6. costs have been high

We’ll address each of these points in turn.

Yes, you can’t get hold of the money until you are 55. Quite a few people have explained to me how they prefer ISAs because they want to get hold of their money early.

It’s a fine idea to retire very early, but it’s quite difficult in practice.

• It requires spending and saving discipline over a period of decades, and your fair share of luck.
• I stopped at 50, and in today’s economy I think a lot of people will struggle even to match that.

But even if you do quit at 40, you can still benefit from a pension.

• I’m assuming that you plan to be alive beyond the age of 55, so just spend your pension then.
• Run down your ISAs between age 40 and 55, and then switch to your pension.

Yes, you have to pay tax on pension income.

• But not that much, and it still works out in your favour.

You’ll get 20% or 40% tax relief on the way in.

• Then your pot grows inside the pension scheme free of any tax (over a long period of time, this makes a big difference).
• When you take out your income, the first 25% is tax free, and the rest is taxed as normal income (note that there are no national insurance contributions to pay on pension income).

So if you had a big enough pension to withdraw income up to the current higher rate threshold of £43K:

• you’d pay no tax on 25% of the income (£10.75K, from the pension tax-free allowance)
• you would pay no tax on the first £11K of what remained (personal tax-free allowance)
• you’d pay 20% tax on the remaining £21.25K

That’s £4.25K of tax on £43K of income – less than 10% tax overall.

• So even for basic rate taxpayers, pensions save tax.

The other complaints are simpler to deal with.

1. Some schemes are inflexible, but you can counter that by investing in more exotic assets in the rest of your portfolio (eg. your ISAs).
2. There have been pension scandals, but they were in DB schemes, not the current DC schemes.
3. Returns have been historically poor, but if you invest in a range of trackers (which all the new schemes offer) you’ll be guaranteed at least average performance.
4. Using these same trackers should also mean that your costs are average, too – in any case, workplace pension schemes now have a charge cap of 0.75% pa.

Make sure that you put most of your money into equities (stocks and shares) rather than cash or bonds.

• Over the long run, equities will give the best returns.

So let’s look at who doesn’t need a pension:

• people who expect to be dead before 55

That’s all, just them.

Next, let’s look at who doesn’t need a workplace pension:

• people who don’t have a workplace, and therefore won’t be offered one.
• people who have lots of debt that they should repay before starting a pension.

So if you plan to die before 55 or you don’t have a job or you have massive debts, look away now.

• Everybody else, keep reading.

I mentioned earlier that your Workplace Pension is free money.

• That’s because under UK law, your employer has to offer you a pension, and to pay some money into it for you.

This is a recent change, under something known in the business as Auto-Enrolment.

• It really should be called compulsory pension offer, or something equally un-sexy.
• In the past, it was up to employers whether they wanted to offer a pension.

The default position has been changed so that you are now enrolled into the workplace pension by default, and have to personally opt-out if you don’t want to be part of it.

• The idea is to reduce opt-out rates through inertia.
• This in turn will reduce pressure on the state pension over the next 30 years.

The roll-out of the scheme has been ongoing for a few years now, and all but the smallest employers now have to offer a pension, and make contributions into it.

• Even one-man bands will be included over the next two years (by 2018).

Let’s look at the legal requirements.

You must be enrolled into a workplace pension if:

1. you aren’t already in a workplace scheme
2. you’re aged over 22 and haven’t reached the State Pension Age
3. you earn more than £10K pa
4. you work in the UK

Even short-term contract and agency workers are covered.

• Anyone earning more than £6K (but less than £10K) can ask to join (opt-in) and can’t be refused.

The minimum contributions are currently 2% of salary pa – 1% from you and 1% from your employer (net 0.8% after tax relief).

• Higher rate tax payers save even more by getting additional tax relief at the end of the year when they submit their tax return.
• The first £5,824 of salary doesn’t count towards these calculations.
• Anything over £43K pa doesn’t count either.

In April 2018, contributions will be raised to 5% pa – 3% from you and 2% from your employer (net 2.4% from you).

In April 2019, they rise again to 8% pa – 5% from you and 3% from your employer (net 4% from you).

So from 2019, the minimum pension offer will be 8%, costing you only 4%.

• The other 4% pa is free money.

8% pa is not enough to be saving, so you need to make more provisions elsewhere.

• But it’s a start, and half of it is free money.

Just a quick word here about salary sacrifice.

You can agree with your employer to give up part of your salary and have this paid straight into your pension.

• Not only does this attract the regular tax relief, it also saves you NICs (your employer saves too, which is why they will be keen to offer this arrangement).

The government has just issued a consultation paper on reforming (ie. taxing) salary sacrifice, as it’s worried about how much revenue it’s losing.

• But payments into a pension scheme are unaffected by this review, so have a word with your employer.

So that’s the mechanics of the system.

Now for the softer advantages:

• the contributions are made automatically for you each month – you don’t have to decide to save for a pension, instead you are paying yourself first
• you’re investing regularly, so you’ll benefit from dollar cost averaging (your money buys more when the market is down)
• your contributions are locked away until you are 55, so you can’t be tempted to spend them on a holiday or a new kitchen

These benefits are not to be underestimated.

There’s also a thing called contribution matching.

This is where your employer offers to put in more than the legal minimum, so long as you match them.

• So if you put in 5% of your salary, they’ll also put in 5%.

This is great, because your contributions attract tax relief – 5% costs a basic rate tax payer only 4%, and a higher rate taxpayer only 3% – and the employer contributions are completely free money.

• So you could get a 10% pension contribution that’s cost you only 3% or 4%.

I’ve used 10% to make the maths easy.

• You should really be saving a bit more than that.
• But if you aimed for 15% in total, that will only have cost you 4.5% or 6%.
• Whatever your tax band, that’s quite a boost.

Some matching schemes are even more favourable than this.

• If your employer is legally required to pay in more than you, sometimes they will match all of your extra contributions rather than just topping up to keep level with you.
• So if you have to contribute 3%, and they have to put in 5%, when you add an extra 5% (to reach 8%) they would also add 5% (to reach 10%) rather than just adding 3% (to match you at 8%).

If you’re in this lucky position, you could be getting 18% of contributions at a cost of only 4.8% or 6.4%.

I hope I’ve convinced you today that:

1. you need to save for retirement
2. pensions are the best way to do it
3. workplace pensions are no longer the poor relations of personal pensions – they have a role to play

So remember: Take up your Workplace Pension Offer

• because it’s Free Money

Until next time.