Auto-enrolment is here and though it may not affect all employees for a few years, it is important to understand what it is, how it works and how it will benefit you.
What is auto-enrolment?
Auto-enrolment is a scheme backed by the government that will see all but the very smallest UK firms required to operate a company pension scheme.
It is designed to supplement the state pension and any private pension employees have to increase pension savings and reduce dependency on the state as life expectancy in the UK increases.
Who will be affected by it?
Virtually all employees will be affected by it, though for many not for a few years. It is not mandatory to join the scheme but if you do you will benefit from an employer contribution to your pension as well as tax relief on the money you contribute.
The majority of employees will be automatically enrolled but can elect to opt-out.
Employees who earn less than £8,105 do not qualify for the scheme and you have to be over 22 years of age.
Unfortunately, self-employed people cannot benefit from the scheme. This is disappointing because this group of workers already pay less towards their pension than most other people.
Public sector workers will not be affected because they already have the opportunity to take advantage of a relatively generous pension scheme run by the civil service.
The government hopes that a total of 11 million people will be enrolled by 2018.
Why is it being introduced?
Auto-enrolment is being introduced to supplement the state pension and private pensions and is designed to increase the level of pension savings in the UK.
As life expectancy increases so does the total ongoing liability of the state. This is why the state pension age is being raised.
Research shows that last year 100,000 people opted out of their company pension schemes, taking the total enrolled to just 2.9 million, the lowest level since 1953.
Pensions Minister Steve Webb said: "The huge gap that we are trying to fill is in long-term pension saving.
"We have got half the workforce building up no pension beyond the state pension, and that is why this system is such a positive thing.
Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), said: "The UK is drifting towards an iceberg when it comes to paying for its old age, and we need radical reform like this."
When will employers have to start a scheme?
From October 2012 all firms with more than 120,000 employees will be required to run an auto-enrolment scheme.
From November 2012 it will be introduced for firms with 50,000 – 119,999 employees. In January 2013 the scheme is extended to firms with 30,000 – 49,999, from February 2013, firms with 20,000 – 29,999 employees will be required to run a scheme.
March 2013 sees companies with 10,000 – 19,999 employees operating auto-enrolment. Smaller firms follow each month until November 2013 when firms with 500 – 799 employees will open schemes.
In January 2014, firms with fewer than 500 employees will be required to operate a scheme with the deadline in stages throughout the year depending on the amount of employees.
Similarly in January 2015, firms with less than 58 employees will need to be ready for auto-enrolment in stages through the year with the timetable completed by February 2018.
How is it different to the state pension?
The state pension is linked to national insurance contributions and though there have been plenty of changes to the rules around state pensions, particularly when people qualify for it, auto-enrolment is different.
Auto-enrolment pensions will be paid for by a combination of employee and employer contributions and tax relief from the government.
It is closer to a company pension scheme which many people have anyway. Auto-enrolment is designed to get companies that don’t run company pension schemes to operate one.
How much will go into an auto-enrolment pension pot?
Initially a total of two per cent of an employees’ gross pay between £5,564 and £42,475 will need to be invested to qualify for the scheme. This will be made up of minimum contributions of 0.8 per cent from an employee, one per cent from employers and 0.2 per cent from the government through tax relief.
Over time this will rise to a maximum total of eight per cent made up of a three per cent contribution from employees, four per cent from employers and one per cent through tax relief.
Fidelity Investments says that for a contribution of initially just £14 a month, employees on an average income of £26,200 could benefit from a total of £6,000 through employer and government contributions over a ten-year period.
It says an employee would have to pay £14 a month for the first year, then £15 a month for the next four years and then £78 a month for the next five years to get the £6,000 benefit.
Julian Webb, Head of DC & Workplace Savings at Fidelity comments: "Only a quarter of private sector workers are currently active members of their employers' pension schemes.
"Whilst there may be specific reasons for some people to opt out of auto-enrolment, for example, high levels of personal debt, in most cases staying enrolled is likely to be the best route.”
Where is the money invested?
There are two sets of options for employers. Small employers who do not have the resources to set up their own scheme can take advantage of the National Employment Savings Trust (NEST). Alternatively the money can be invested in an existing company pension scheme or through a UK insurer.
What are the charges?
The NEST scheme has an annual management charge of just 0.3 per cent of the annual investment amount. Investors also have to pay a charge of 1.8 per cent on every contribution. Existing company schemes and schemes through insurers will have their own charges that will vary.
What will the pension be worth when it matures?
For some one earning £20,000, paying the full eight per cent a year, they would be contributing £1,155 a year to their pension pot. A relatively young employee continuing this for 40 years would be able to save £46,200.
Assuming a rate of return of three per cent of interest a year on the invested funds, the employee would end up with a pension pot of £88,600.
Annuity rates are low at the moment and assuming they stay that way this would entitle a healthy retiree to a pension of around £250 a month at today’s prices in addition to the state pension and any private pension they have.
What are the benefits?
The benefits are two-fold. Firstly an individual’s own money that is invested has years to grow in value, though the real value depends on the performance of the fund and the rate of inflation between when the money was invested and when it is accessed.
The second benefit is free money. Your employer is required to put money into your pension fund. Initially this is a minimum of one per cent but will rise to three per cent. A further contribution through tax relief comes from the government, initially 0.2 per cent but rising to 0.8 per cent.
What are the criticisms?
The main criticism is that for most employees the pension it produces, if annuity rates stay low, will not be enough to cover the cost of living, even in addition to the state pension that most employees will also qualify for.
However, the difficulty is that if more of an employees’ take home salary is used for auto-enrolment more people will opt-out, not to mention the extra costs to employers.