Employers that currently have no pension scheme will have to create one
Starting in October 2012, 11 million people who are not in a pension scheme at work have had to join one, whether they want to or not. It is called auto-enrolment and, as its name suggests, people in work will automatically be put into a pension scheme run by their employer. It will not affect everyone at once and will take five years for the scheme to cover the working population, starting with the biggest companies. Those who work for an employer with at least 50,000 staff will have been auto-enrolled by the end of this year.
Employers with a pension scheme can enrol their staff into that scheme – as long as it meets certain minimum standards – or into a separate auto-enrolment scheme if they prefer. Employers that currently have no scheme will have to create one.
By the end of 2013, auto-enrolment will extend down to employers with at least 800 workers. Month by month, more will be included until, by September 2017, every employer will have to provide a pension scheme for their employees and pay into it. That will include employers with just one worker. Employers with very good pension schemes may defer auto-enrolment for existing employees until 2017.
Age and pay limits
Employees must be automatically enrolled into a scheme if they are aged from 22 to state pension age (currently 65 for men and about 61½ for women) and earn at least £8,105 a year (about £156 a week or £676 a month). That level of earnings is called the ‘earnings trigger’.
Employees aged 16-21 or from pension age to 74 can join if they want to, and so can anyone aged 16 to 74 who earns less than £8,105. People aged 75 or more (or under 16) cannot pay into a pension.
At first, the minimum contributions will be modest. Up to September 2017 they will be just 2% of a band of pay between £5,564 and £42,475 a year. These lower and upper thresholds will be revised each April. Your employer will put in 1% and you will pay in the other 1%. However, some of your contribution will come from tax relief so your actual contribution will be 0.8%. Tax relief of 0.2% of pay will be added even if you do not pay tax. If you earn £200 a week, the minimum contributions will cost you just 75p a week and the total amount going into your pension will be £1.86. People earning less than £5,564 who choose to join the scheme will not get any contributions paid by their employer.From October 2017 the minimum contributions from you will rise to 3% including tax relief, and 2% from your employer; a year later they will rise again to 5% and 3% respectively.
You or your employer can pay in more than the minimum. If you are auto-enrolled into a scheme that has higher contributions than the minimum, then you will have to pay those higher contributions.
If employers do not have a pension scheme, they will have to create one. There are a number of schemes around that they may use. One is called NEST, which is a low-cost state-sponsored scheme. Another low-cost one, which provides pensions to almost all workers in the Netherlands, is called NOW – and there are others. One advantage of NEST and NOW is that your pension pot can stay in the scheme even if you change employer; and if you become self-employed, you can continue to pay into it.
If your employer already has a pension scheme, you may be auto-enrolled into that scheme. But some firms are keeping existing schemes and setting up separate auto-enrolment schemes. Normally staff will be able to move to the main scheme after a certain time.
People who are self-employed or work as a contractor will not be subject to auto-enrolment. But at least one major pension scheme – NEST – will allow them to join, pay in their own contributions up to a maximum of £4,400 a year and get full tax relief on them. You cannot move an existing pension fund into NEST, but this may change in future.
Although eventually almost everyone in work will be auto-enrolled into a pension scheme, they will also have the right to leave the scheme at any time. If you are auto-enrolled and leave within one month, you will get back any contributions that have been paid. If you wait longer than that, any contributions made by you and your employer will stay in your pension pot.
If you do opt out, you will be auto-enrolled into a scheme again every three years and every time you change employer. The idea is that it will be more hassle to be out than in, so people will tend to stay. Employers cannot offer you any inducement or advice to opt out. If they do they will be breaking the law.
Normally, being in a pension scheme is a good thing. You will usually pay in around half the amount that ends up in your pension fund – the rest will come from your employer and tax relief. But for the first six years until 2018/19, the minimum contributions will be very small, so the amount contributed to the scheme will be tiny. The total paid in for someone earning the national average wage – £26,000 a year – will be barely £400 over the whole year. For people in their fifties who have a decade or so to pay in, the total in the scheme will not be that great. Even a pension pot of £10,000 will buy a pension of only £500 or so a year at 65.
If your total pension pots are worth less than £18,000, you can take them out in cash. A quarter of the money is tax-free and the rest is added to your income and taxed. Even if you have more than £18,000 in total pension savings, an individual pension pot of £2,000 or less can be cashed in on the same terms.
The danger is that the pension you end up with will mean you get less help from means-tested benefits – and that loss could cost you more than you have paid into your scheme. Generally speaking, the lower your pay and the closer you are to retirement, the less worthwhile it will be to stay auto-enrolled. However, if you (or your partner if you are in a couple) are likely to have an income in retirement that will take you out of means-testing altogether, then paying into an auto-enrolled pension can never leave you worse off.
Your employer will choose the pension scheme into which you are auto-enrolled. But individuals will have a choice within that scheme about how or where their fund is invested. For people who do not want to make those decisions, there will be a low-risk so-called ‘default fund’. But there is no guarantee that any fund will be worth more when you retire than the money paid into it.
Your employer will tell you when you will have to pay into a pension, the details of what it will cost you, how you can opt out, and your pension choices.
* Read Paul Lewis's money articles every month in Saga Magazine.