Ryan discusses frequently asked questions around pensions, employer pension contributions and how much you should be paying into your pension.
Firstly lets start off with some background…
Following the introduction of auto-enrolment through the Pensions Act 2008, all employers in the UK must put qualifying staff into a pension scheme and contribute towards it. Yours and your employer pension contributions are invested to target growth so when you retire you will have some provisions towards providing you with an income for your later years.
Some schemes are Defined Benefit schemes, through employers such as the Police or NHS. When at retirement the pension you receive is linked to your earnings and paid more like a salary which is typically higher the longer you have funded the pension.
The majority of individuals in the UK will have a ‘money purchase’ arrangement – where your resulting pension at retirement is linked to how much you have contributed and the investment performance of the funds your contributions have been paid into. The below article details more about money purchase pensions and the investment principles behind these.
Why do I need a pension at retirement?
In the future it is not guaranteed what State Pension will be available for those early in their working lives, so ensuring you have adequately funded your retirement is now more important than ever.
How does automatic enrolment work?
Under auto-enrolment your employer will set you up with a workplace pension. This will be set up typically after a period of three months at a new job. There are minimum contributions that you and your employer have to make into your workplace pension. Employees typically pay 5% and your employer will contribute 3% towards your pension . The percentage of your earnings this is applicable to is typically your ‘qualifying earnings’ which is the amount earned (before tax) between £6,240 and £50,000.
For example someone earning £26,000 per annum would contribute £988 per annum (£26,000 – £6,240 = £19,760, £19,760 *5%) themselves to their workplace pension. Then their employer would contribute £592.80 per annum (£26,000 – £6,240 = £19,760, £19,760 * 3%).
Some employers have more generous schemes, for example who meet contributions on all earnings, not just those that qualify, or pay in more than 3% per annum.
Am I eligible to join my employer’s pension?
An employer will automatically enrol you into a pension scheme if you are:
- Aged from 22 up to state pension age
- Have earnings before tax of at least 10,000 per annum (or £833 per month, or £192 per week)
If you do not qualify, your employer may not automatically enrol you. You are able to ask to enter a scheme and receive an employer contribution if you earn more than £120 a week/£520 per month/£6,240 per year.
If I can afford to put in more should I?
Definitely think about if you can contribute more to your employee pension. A pension has multiple tax advantages. Funds can grow tax-free, at retirement you can typically take 25% of the fund tax-free. There are products out there with flexible options to effectively plan how you draw income. Pensions do not fall into your estate for inheritance tax purposes.
Of course in your 20s and 30s you might have other goals like buying your first home, or having children. Due to this a lot of people end up waiting until their later lives to think about pension funding. The earlier you contribute to a pension (subject to affordability) the longer your pension has time to grow, and weather volatility in the short-term.
Should I just leave my pension alone?
Definitely not. It is important to know what you are invested in and how much risk this takes. The younger you are, the longer you have between now and retirement. This means your pension would be able to take more risk as it will have a longer timescale to target growth.
It is also important to consider how well-funded the pension is. You will receive annual statements which include projections of how much the fund would be worth at the retirement date on the plan. These figures are indicative, and actual fund performance is the most important factor. But if the resulting pot does not seem significant enough to meet your needs, it would be worth considering additional funding.
With workplace schemes, you typically have options called ‘Lifestyling’. This is where your funds could de-risk as you approach your retirement age, and you will have options to invest in multiple funds. Whilst some more adventurous individuals may want to focus in areas they feel would have more long-term prospects for growth. It is important to keep in mind the increased risk.
I would recommend reviewing the pension at least every six months in the early years. When you are approaching retirement (within 10 to 15 years) it is more important to speak to an adviser to review what provisions you have. Then an estimation of what this would provide in retirement.
How do I know what is the best option for me?
The earlier you start the longer your holdings are able to weather volatility and target growth. Despite this investment principle, never choose an investment that takes risk in excess of how much you feel comfortable.
Financial Advisers are able to use risk profile and cash flow tools to consider how you feel about risk. As well as how this would look regardless of your timescale.
When you are first enrolled you will be in a default fund. But the pension provider will be able to provide you with some options on what you are able to invest in. I would suggest a lifestyle strategy that de-risks your portfolio in the later years to be the most appropriate. However, seek advice for more information on what would best suit you.
Your employer may also have involved an adviser in the process of setting up auto-enrolment. They may be able to help with identifying a suitable level of risk and suitable strategy going forward.
For more information, seek financial advice. Your first meeting with a Kingswood adviser is free without any obligation to you. Click here to start the conversation.
Ryan Smith, Kingswood Wealth Planner
The value of your investments may go up as well as down. The above does not constitute as advice.