MSE News: Automatic pension enrolment - what it means for you

JeffMinter

Many are saying it's free money because employer contributions are added to your own, but it's only free when you get it back - and that's in 40-50 years time! And even then, you have to buy an annuity offered at that time period - AND you have to live around 20 years to get back what you paid in in the first place. So it's an extremely risky, long term investment that is contingent on you staying alive for the next 70 years before it begins to pay off

dunstonh

And even then, you have to buy an annuity offered at that time period

No you dont.

AND you have to live around 20 years to get back what you paid in in the first place.

No you dont. The breakeven point is earlier than that where employer pays in.

So it's an extremely risky, long term investment that is contingent on you staying alive for the next 70 years before it begins to pay off

Wrong again. If you die before retirement, the money is paid out tax free to a beneficiary. (including the amount built up by tax relief and employer contribution. Indeed, on death, it would pay out more than any savings or investment in another wrapper.

jamesd

You don't have to wait 40-50 years unless you start work at age 15. Personal and work defined contribution pension income can be taken from age 55.

It doesn't take twenty years to get back what you pay in. It can be as little as a year with employer matching and tax relief.

Lets pretend that you're a higher rate tax payer with employer matching and also 50% of the saved employer NI going into the pension pot.

You deduct £1,000 of gross pay. You save 2% employee NI on the £1,000, £20, don't pay £400 in tax and get half of the employer 13.8% NI added to the pension, £69, and the employer matching £1,000. The situation then is:

Your net cost: £1,000 less £400 tax relief less £20 NI = £580
Your gross pension: £1,000 + £69 + £1,000 = £2,069

Now at age 55% you take a 25% tax free lump sum from the £2,069: £517.25.

Congratulations! On day 1 you've just got back 89% of the money you spent!

Now you take 5% a year of the remaining £1,551.75. £77.58 a year. You've now received £594.83 on £580 initial cost so you're ahead after just one year.

Now you get to laugh at anyone who believed the claims that pensions were a bad deal, as you collect that extra income at effectively no cost to you for the rest of your life. Likely more than 35 years if you do it at 55. And that could be longer than you spent working.

It takes longer for a basic rate tax payer but it's still a good deal.

JeffMinter

Thats the best case scenario, for a case where you start paying into the pension at 54. The younger you start, the further away you are from breaking even, because not only are you x years away from retirement, but you are also putting more and more in, thus pushing the break even point further away.

Also you pay tax (higher rate?) on the payments after the lump sum.

dunstonh

The younger you start, the further away you are from breaking even, because not only are you x years away from retirement

No its not.

Also you pay tax (higher rate?) on the payments after the lump sum.

So would most alternatives. However 25% of the pension would be paid out tax free. You also have your personal allowance to use up.

jamesd

That was a break even calculation: how long it takes from starting to take the pension until you get the money out. Not twenty years in that case, just one.

For all forms of retirement planning you can expect to wait until you retire. That's why it's retirement planning. You're not going to go and take it all out and blow it just because it happens to be in a S&S ISA when it's your retirement income pot!

It's common for people to drop from higher rate to basic rate tax on retirement but yes, the money is taxable so it takes a bit over a year for cash to beat the cost. If you don't like that example you can always do a basic rate calculation, again using salary sacrifice, because that's how the lower end auto-enrolment is expected to work.

If you start earlier you'll probably have some investment growth. I didn't bother allowing for that because it was so easy to make the point that it doesn't take twenty years without even allowing for that.

If you haven't tried it yet you might try comparing identical payments into a pension or S&S ISA with identical investments used in each. You'll find that even after tax you get more income from the pension per Pound paid in. But I've done that many times already so it's probably more useful for you to play with it to prove it to yourself.

BerlinWall

Opting in or out is only one part of the question. How does one know their employer has chosen a good value for money plan for them? How do you know that you are saving enough? All these figures are confusing.

JoeCrystal

Well, in my opinion, if the employer is contributing more than the minimum level into a pension scheme, then it is really the best value as you will not be able to get that free money.

As for saving enough, that could be partly solved by two means, both equally important. What kind of retirement you will need when retiring. Now, if you are so far away from your retirement then make the best estimate on the income you would like to have. The second way is figuring out how much you need to save up to achieve that income, this can be done by using any pension calculator like this one a try.

On the other hand, if your employer provides defined benefit pension scheme, it is considered insane that a person will opt out of that. There are very few reasons why it may be a good idea but I guess it can be counted on one hand and do not apply to the vast majority of the population.

Cheers,
Joe

dunstonh

How does one know their employer has chosen a good value for money plan for them?

Read the paperwork would be the easiest way to tell.

How do you know that you are saving enough? All these figures are confusing.

If you cant read and understand it then get an adviser who can or someone that at leasts knows what they are doing to explain it (making sure you avoid someone equally as clueless or vindictive - yes workplace is full of mouthy know-it-alls who know nothing and spread misinformation).

However, any free money from the employer is a good thing.

GhIFA

BerlinWall wrote: »

Opting in or out is only one part of the question. How does one know their employer has chosen a good value for money plan for them? How do you know that you are saving enough? All these figures are confusing.

The charges for any DC scheme should be clearly documented. If it is a Group Personal Pension arrangement then it is likely there will be a scheme adviser - if having read the documentation you are still unsure then speak to them.

In terms of saving enough - keep an eye on the projections that will be supplied with your annual statement, and adjust your contributions accordingly depending on what the projections are showing you. Again, if you're unsure of what these are showing then speak to the scheme adviser.