Pension or ‘pay rise’? My Q’n’A on auto-enrolment & what it means for you

Young workers’ payments into workplace pensions go up this month. So why should my generation stick with auto enrolment – and how could it be improved for all?

Iona Bain

The times, they are a-changing.

No, I’m not just talking about the “mad riddle” that is Brexit, to quote that great modern philosopher Danny Dyer.

You might not realise it, but the pensions industry is currently going through a seismic moment.

And it’s happening right now in your pay packet. Yes, I’m serious! Right now, we are seeing a major milestone in the nation’s big pension experiment, one that you (perhaps unwittingly) are participating in.

If you’re a full-time employee working for a company and earning over £10,000, chances are that you have been auto-enrolled into your company’s pension (unless you actively went and opted out).

At the beginning of last year, you were likely to be paying just 0.8 per cent your salary into that fund.

Last April, that contribution jumped to 2.4 per cent. Now? You’ll be paying 4 per cent, with your employer chipping almost as much (3 per cent).

We answer your questions about what all this means…

How much more am I paying into my pension now?

It’s hard to estimate right across the board (and I don’t want to send you to sleep) but a worker on £20,000 will have seen their deduction rise fivefold from under £10  to £49 a month, and those on average earnings of £27,000 will be seeing £73 a month disappear, against £14 a year ago and £43 currently.

I take this is a good thing for me, like yoga and Headspace?

Generally, yes. Even if you consider this to be a minor pay cut – and I wouldn’t blame you if you did – tax cuts and pay rises will soften the blow. It’s hard to believe that things are actually going pretty well in the economy, but workers are enjoying their strongest real pay rise in two years, with regular wages up 3.4 per cent (or 1.2 per cent after inflation).

The personal tax allowance has also gone up, from £11,850 to £12,500, so that means you’ll be keeping more of your earnings from HMRC. For low earners aged over 25, the national living wage has gone up by 4.9 per cent, but younger workers are still getting an above-inflation pay rise as of this month.

Furthermore, financial firm Quilter has done the maths and figured out the average pension pot will be 66 per cent larger as a result of the 2 per cent rise, largely on account of the added freebie of employer contributions. Ian Browne, retirement planning expert at Quilter, said:

“With that knowledge, people are likely to think a lot more carefully about whether the extra couple quid in their pocket per month today is really so much to give up.”

So will pension opt-outs will be low?

Probably. The pension company Royal London says the opt-out rate for automatic enrolment schemes rose by just 0.4 % in the quarters before and after last April’s contribution hike.

Certainly we are seeing a timely boost to pay packets that will disguise those higher pension contributions and keep most young workers enrolled in their scheme. If anyone is likely to opt out, it is the over-50s who feel they have already built up enough pension money.

The Department for Work and Pensions found in interim research were even aware that their pension contributions would be going up this month, but most had a positive or neutral attitude to the news. The report said:

“Some were pleased that the increased rate would help them save more for retirement. Very rarely, workers expressed some concern about affording the planned increase, but even then they did not suggest it would affect their decision to remain in the scheme.”

But there are dangers in being complacent. The report warned that most enrolled workers were not making an active decision to remain – or save more – into the schemes:

It was common for workers to describe remaining in the scheme as an easy decision, since they perceived the employer contribution as ‘free money.’ Although workers often said they wanted to save more for retirement, very few were contributing more than the minimum rate to their pension.”

Does this mean I don’t have to think about my pension?

via GIPHY

On the contrary. The DWP research, and countless other commentators, have pointed out the deficiencies inherent in the auto-enrolment model. Firstly, the contribution rates currently made by most workers (and employers) are not going to be enough by most reasonable standards (and certainly when compared to the generous outcomes of final salary schemes, near-extinct in private businesses but still prevalent in the public sector).

The Association of Consulting Actuaries has said that contributions need to rise gradually from 8% to between 12% and 14% of earnings to achieve decent pensions. The exact figures are disputed but nearly no-one will argue that current pension contributions are adequate.

Ian Browne said:

“Relying solely on the power of inertia for the continual success of auto-enrolment is the equivalent of burying our heads in the sand. Over the course of the next year the industry and government need to do more to ensure we are boosting engagement and education.”

There is a growing consensus that people need to start “engaging” with their workplace pensions so they stay opted in and (ideally) contribute more.

So what does “engagement” mean?

Welcome, my friend, to the most troublesome debate in the pensions industry.

The notion of engaging people with their pensions is controversial because generally speaking, pensions need to be left alone in the long-term to grow in the stock markets, managed by fund experts who can make the right decisions at the right times. For instance, the years before you get your pension are seen as critical and delicate, because you don’t want your fund to be disproportionately depleted by an economic crash just when you come to retire. Similarly, younger workers need to be ideally taking more risks because their money has a longer time to really sweat in the markets.

People can and do make bad decisions about their money, largely because of poor financial education, natural investor psychology and (sometimes) the complexity of understanding investments. And in the past, it was only the employers and pension funds that had to worry about honouring (often excessively) generous pension promises made to employees. The individual was never in a position where they needed to think about their pension – until they came to retire.

But many in the pensions industry argue that things have irrevocably changed and now there is a greater long-term risk of leaving young people in the dark about their pensions, and particularly depriving them of choice about where they can invest. Competition – which generally leads to better products and services in a well-functioning capitalist market- seldom flourishes if people don’t know what “a good deal” looks like, so while regulation has intervened to stop funds charging us excessively, we may still suffer from poor or mediocre returns if funds aren’t properly accountable to us.

So is auto-enrolment working?

via GIPHY

If you judge auto-enrolment’s success by the number of people who have stayed in workplace schemes (so far), it has been resounding. If you judge it by the knowledge, choice and information that people have about their workplace pensions, then maybe not.

The current auto-enrolment system is rigid in the extreme. You can’t generally raise your workplace contributions and your choice of funds is probably very limited. So if you’re worried about climate change, you might be appalled to find out where your pension is invested.

Nathan Long, senior analyst at financial giant Hargreaves Lansdown, commented:

“The best pension schemes in the future will be those where the provider has been able to promote positive retirement planning among members. The telltale signs of how well the company pension provider resonates with employees include the number of staff logging into their pension, the proportion who’ve upped the amount they pay in and the number that are taking an active interest in their pension investments.”

At the moment, it is likely that the only interaction you will have with your workplace pension is through an annual (physical) statement, sent to you once a year. But it is generally overlong, stuffed with impenetrable jargon and almost completely unhelpful for your purposes. This is being improved by bigwigs in the pensions industry like Quiet Room and LV – thank god – but don’t expect fancy websites and swish apps for some time. We’re talking about the pensions industry here!

You may also end up moving away from your job, whereupon that company pension will go dormant. No-one will be contributing to it anymore but fund managers will still be taking a charge. It may be a teeny tiny pot if you have only worked at the company for a short time and you may well lose track of it. Dozens of these small pots, all stranded without their owner’s knowledge, will not make for a good pension.

Moreover, if you’re a low earner, you may be overcharged for your workplace pensions if you are in something known as a Master Trust.

The former pensions minister Ros Altman recently spelled out the problems:

“If employers are enrolling a worker who earns under £12,500 into a Net Pay pension scheme (almost all MasterTrusts use the Net Pay system), then these workers will be inadvertently paying 25% extra for the same pension as those earning more than them. Employers have no legal obligation to choose a scheme that suits their low paid workers. Regulators have only worried about whether employers have chosen a scheme, but do not check whether the scheme is appropriate for all workers… surely there is a moral case for stopping this scandal, rather than just letting it run on.”

The government recognises most of these shortcomings and (in all fairness) is working to tackle some of them, albeit slowly. The Pensions Dashboard is designed to help people see all their workplace pensions in one place and the Pensions Minister Guy Opperman has committed to getting an initial PD up and running this year – though the industry is highly sceptical about this goal.

What do I need to do?

If your employer allows you to put in more to your pension through “contribution matching”, do it. Otherwise, stay opted in – but check the terms of your pension scheme and write to me if you suspect you are in a Net Pay scheme.

Meanwhile, make sure you have your basic savings sorted out (I know I keep banging on about this, but your pension won’t be much good if the boiler goes kaput – you can’t access it until you are 55).

Savings outside the pension, in banks and building societies, rose by only 0.4% last year, a drop from 3% in 2016 and the weakest rise since data started being collected in 2007.

The financial giant Hargreaves Lansdown have said:

“Our statistics show that almost one in four people have no savings at all. And even among those who have put money away for emergencies, more than one in five couldn’t last longer than a month on their savings.”

If you can afford to put more into a personal pension or Lifetime Isa, then take advantage. The latter comes with a government bonus of 25% but you can only save up to £4000 and whatever you do, don’t touch the money. Like, ever. Until you’re allowed to do so without penalty, of course. It’s annoying that the LISA comes with a “dead decade” that doesn’t allow you to save between 50 and 60 but I’ll be doing my bit to try and get this changed…

You can also put more into a personal or self-invested pension each year. But beware the tax relief ceiling which keeps coming down every year. You can open either with most digital wealth managers who will take care of the investing decisions for you or you can take a leap and invest your own pension through a DIY platform. But on your head be it!

What do you think? Are you staying in? Or getting out? What’s your pensions game like? Leave a comment or tweet me @ionayoungmoney.

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