The plan:
The Government has introduced a compulsory pension scheme, which means that millions of UK employees will gradually see a slice of their salaries being automatically diverted into a pension pot for their retirement. Employers are obliged to contribute too with the government also adding to the pot through tax relief. The system, known as Automatic Enrolment is being phased in over six years, starting with the biggest employers. The scheme is compulsory however, employers who already have a company pension scheme in place will be exempt. The self-employed are left out in the cold and will need to make their own arrangements.
The cost:
At first, an employee will only see a minimum of 0.8% of their earnings going into their workplace pension. Their employer will be obliged to add a contribution that is equivalent to 1% of their earnings. Tax relief adds a further 2%. These amounts will however increase to a minimum of 4% from the employee, 3% from the employer and 1% in tax relief from October 2018. This means a total of 8% of an employee’s earnings will go into their pot as contributions.
The investment:
Importantly, the current standard pension rules would also apply to auto enrolment, so any pension fund built up would not be accessible until the employee reached the age of 55. In the meantime, the pension firm, insurance company or government backed organisation which was running the scheme would give the employee a choice of how they wanted their fund invested. This would of course depend on how much risk they wished to take and whether or not they would want to consider options such as ethical investments or tracker funds. For those who weren’t able to make a choice, there would be a default “lifestyling” option, which would normally start off relatively aggressively, lowering risk in middle age and then taking a more defensive approach as retirement approached.
The results
Unlike a final salary scheme where results are predetermined, like personal pensions, the results of such an investment would be quite difficult to predict. This would of course depend on the performance of the funds, the contribution levels, age at commencement, the retirement age and whether or not the employee had continuous service and therefore continuous contributions.
As a ball park figure however, a 30 year old earning £30,000 per annum and contributing to a scheme until the age of 65 continuously could expect a pension in retirement of £3,250 per annum in today’s terms, assuming fund growth of 4% per annum and annual inflation of 3.5%* (Source: Assureweb). Add to this the state pension of approximately £5,700 and you will note that the scheme is more about getting by in retirement than living a lavish lifestyle.
Conclusion
Auto enrolment is a good thing. However, for many people, the combination of auto enrolment and the state pension will not be enough in retirement – even if they were to contribute in full. However, it will be good for people to get into the savings habit, as they may choose to have parallel savings to top up the auto enrolment scheme. What this illustrates is that anyone for which “getting by” is not enough will need to plan and make sacrifices to ensure that they get what they want. My advice would be to engage with an independent financial adviser who should be able to give them a heads-up regarding what they can expect.
