Pension contributions have recently risen for many people, but the increase may still not be enough to fund a comfortable retirement.
The latest round of pre-planned increases to minimum pension contribution rates under automatic enrolment (AE) workplace pensions came into effect in April. If you are one of the 10 million people who have been automatically enrolled, then broadly speaking, provided your yearly earnings are at least £10,000:
- Your employer must now contribute a minimum of 3% of your ‘band earnings’ into a pension (band earnings in 2019/20 are between £6,136 and £50,000); and
- You must make up the balance to bring the total contribution to 8% of ‘band earnings’. So, if your employer pays the minimum 3%, you have to contribute 5%. In most instances you will receive at least basic rate tax relief, which will bring your effective cost down to 4%.
The 8% total contribution figure is widely quoted, but a lot of people overlook the fact that it does not apply to all earnings. In fact, the true AE contribution is approximately 6.2% of total average pay – based on the Office for National Statistics’ latest (February) estimate of average pay of £528 a week (£27,508 a year). There are similar effects across the pay scale, with the maximum true rate of contributions approximately 7% of total pay, which is at the ‘band earnings’ ceiling of £50,000.
CURRENT CONTRIBUTIONS ARE NOT ENOUGH
Despite the increases, the government accepts that the current level of AE contributions falls far short of funding requirements. In the foreword to a Department for Work and Pensions report on the future of AE pensions, published in December 2017, the then Secretary of State for Work and Pensions said,
“…we recognise that contributions of 8% are unlikely to give all individuals the retirement to which they aspire”.
His proposals included:
- Removing the lower limit on ‘band earnings’, so that the 8% was based on full earnings (up to £50,000);
- Reducing the minimum age for inclusion in AE from 22 to 18; and
- Encouraging people to save more than the 8% level.
Eighteen months (and two new Secretaries of State) later, there have been no further developments. The fact that there have been AE contribution increases in both April 2018 and April 2019 may well have encouraged the government to pause, if only to see the reactions of employees.
WHAT IS THE SHORTFALL?
So how much should your pension contributions be?
As far back as 2005, the Pensions Commission acknowledged that the state pension with additional AE contributions of 8% would only provide around half the level of savings needed for most people to enjoy an adequate retirement. The implication is that the contribution rate should more than double for the average employee.
More recent statistics on longevity and the number of people remaining in work beyond usual retirement age have made the picture even more complicated. But how much should your contribution levels increase? The amount will depend on several factors including:
- When you plan to retire and whether that is before you reach your state pension age;
- Your existing level of pension savings, including state benefits;
- Other savings on which you can draw in retirement; and
- Any limits imposed on you by the pension annual and lifetime allowances.
The calculation can become complex very quickly, so why not ask us to carry out an assessment of what your personal contribution rate should be?
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