Saving early for life after work
The pensions landscape has changed significantly in recent years, but this will probably have gone unnoticed for many people entering the workplace as the subject of pensions is rarely one that grabs their attention. To those more in the know, this is a shame as its relative importance cannot be understated with the basic state pension (£8,456.20 per annum) falling significantly short of that recommended to secure a comfortable retirement income. Typically it becomes greater focus when half way through working life and by then, it can often be too late to build a significant pension pot. Whilst this approach hasn’t changed much over the years, other factors such as longevity and future health care needs have put a higher priority on this and as such those particularly in their early years in the workforce do need to consider what they pay towards their future pension provision.
As a positive, larger employers first became required to offer a workplace pension in 2012 under auto-enrolment. This phased across all companies depending on the size of their workforce with all entities requiring to offer a pension provision by April 2017. The scheme has proved successful and has resulted in approximately 10 million extra people saving for their retirement since its inception.
Not so long ago, many employers offered a work placed pension that operated under what is known as a defined-benefit arrangement. Under this format, employees would be due a guaranteed pension based upon their years in the pension scheme and their pay at retirement funded by their own contributions in addition to employer contributions that were often significantly higher than the employee’s. For many employers these became unaffordable to offer especially with falling investment returns and the increase in the retirement age meaning these pensions were in payment for longer. These schemes do still exist but are continuing to disappear at a fast rate.
The most common provision these days is what is known as a defined contribution arrangement which again both employee and employer pay into, but this builds a pot of money rather than a guaranteed pension. A positive these days is that there are improved flexibilities with what individuals can do with their pot which they can do from as early as 55 years of age. They can still use this to buy a traditional pension through an annuity, but equally they can take out a lump sum payment of 25% of this pot (potentially tax free) and then draw down the remainder over time. Residual amounts can even be passed on to future generations. This is all good news, but with these increased choices, an individual is encouraged to take expert advice as many run the risk of their pot running dry too soon.
Under the auto-enrolment workplace pension rules, the government has directed employers (and employees) to pay the minimum contribution they need to make and this has incremented over a 3 year period with the final staging due this April. The auto-enrolment arrangements have been such that individuals are automatically put into this arrangement (but have been able to opt-out). Since 2012, opt-out levels have been encouragingly low and this continued to be the case when minimum contribution levels increased last year. This April the minimum contribution levels are due to be 5% for the employee and 3% from the employer and it is hoped opt-out rates remain low.
It is believed that many employers operate their schemes at minimum levels with little or no encouragement to their employees for paying in more. The individual will perhaps understandably be of the view that this will eventually provide a comfortable income to live on. However, many commentators will argue these levels are insufficient to provide enough income for a comfortable retirement.
Auto-enrolment has helped kick-start this important agenda – but more needs to be done in order to improve pensions knowledge and understanding in a way that engages younger employees so they are better informed and make the right decisions on pension matters.
Blog written by George Perry
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