Personal contributions set to increase five-fold over next 13 months
Increases could give average earners an extra £160,000 over their career
Savers who opt out could be tens of thousands of pounds worse off
From 6 April 2018 the minimum amount people who have been auto-enrolled into their workplace pension have to contribute is going to increase from 0.8% of relevant earnings to 2.4% (1% and 3% when tax relief is included). It will increase again to 4% of relevant earnings a year later (5% including tax relief), meaning a five-fold increase over the next 13 months (see table 1 below).
For someone on an average UK salary of £27,000 a year, this will equate to their current annual pension contribution increasing from £169 today, to £517 in April 2018 and £876 in April 2019 (see table 2 below). This assumes they get an annual pay increase of 2%.
These increases are significant but investors should resist the urge to opt out of their workplace scheme because the increases are essential to ensuring they have adequate pension savings. As well as personal contributions increasing, people will also get more from their employer and the Government in the form of tax relief so the overall impact on their fund size can be significant over their career.
If auto-enrolment contributions stayed at their current level, someone on an average salary of £27,000, increasing by 2% a year, would build a pension fund of just £56,965 over a 40 year career. With the increases in contributions over the next 13 months, that figure could soar to £218,791, an increase of £161,826 (see table 2)
Someone earning £20,000 today could see their pension fund boosted by over £100,000 by the additional contributions and the impact for people earning £45,000 or more is even more significant.
Tom Selby, senior analyst at AJ Bell, comments:
“The increases in auto-enrolment pension contributions might feel significant but they are absolutely necessary. At current minimum contribution levels people’s pension savings are simply not going to be enough, even if they have decades to go until they retire.
“If at all possible people must resist the urge to opt-out as contributions increase. Over a 40 year career for someone earning £27,000 a year, the additional contributions could add just over £160,000 to their pension fund. This is because as well as their own contributions, their employer has to pay in more and they get an additional bonus from the Government in the form of tax relief on each contribution.
“From April, someone earning £27,000 will see just £29 extra a month going into their workplace pension through auto-enrolment, or less than £1 a day. That all of a sudden makes the prospect a lot less daunting and for many, a bit of careful budgeting will allow them to absorb the increase without making drastic changes to their lifestyle.
“Anyone considering about opting-out needs to think long and hard about what it will mean for their long-term retirement prospects. People who do quit their workplace pension are likely to be tens of thousands of pounds worse off over their career and face living on the state pension, which is currently worth under £160 a week.
“This is, of course, just the beginning of arguably the biggest test of auto-enrolment as contributions ratchet up to 8% of relevant earnings. Even at this level someone earning £27,000 would end up with a pot worth around £219,000 – that might sound like a lot but would only buy a single-life, inflation-linked annuity worth £7,800 a year***. Anybody who wants more than that therefore needs to think about upping their contributions beyond the minimum level.”
Table 1: Changes to minimum auto-enrolment contribution levels:
Table 2: The changes to minimum auto-enrolment contributions for three starting salary levels (based on relevant earnings which is salary minus £5,876) and the difference in fund value after 40 years if contributions were not increased:
Starting salary, increasing by 2% per annum
Annual personal contribution now
Annual personal contribution post April 5 2018
Annual personal contribution post April 5 2019
Annual total contribution now*
Annual total contribution post April 5 2018*
Annual total contribution post April 5 2019*
Fund value after 40 years**
Fund value after 40 years** with no contribution increases
*Including employer contributions and Government tax relief
**Assumes 4% investment growth after charges
***Source: Money Advice Service annuity calculator (quote obtained 9th March 2018)