Wages set to drop as workplace pension savings rise

Watch out for a cut in your income as the workplace pension contribution increases next tax year

Is a short-term dip in your take home pay worth it for a long-term financial boost? Will it make a difference anyway? (Shutterstock)

It was one of the biggest shakeups in the way we save – the automatic inclusion into a workplace pension. It has been a massive success, saving millions of Brits from an unrelenting future trying to make ends meet on the state pension alone.

Now though, the first in a series of jumps in the amount siphoned from our pay packets every month is set to test just how much we’re prepared to pay today for a survivable tomorrow.

So far, employee contributions have been just 2 per cent, a small monthly sacrifice that was not too painful. In fact, more than nine million people who did not previously have pension plans have been signed up to the scheme.

But that was the easy part. From April, the contributions jump from 2 per cent to 5 per cent. From April next year they jump again to 8 per cent of an employee’s salary.

Research from Fidelity International shows that the jump will make a big difference to contributors’ retirement savings.

A 33-year-old earning £35,000 who saves the 2 per cent rate can expect a total pension pot of £94,092 by the time they reach retirement. By accepting the automatic hike to 5 per cent, that pot reaches a potential £235,229. Once it jumps to 8 per cent next year, their likely total pension pot come retirement would be £366,445.

Carolyn Jones, head of pensions product at Fidelity International, says too much reporting has focused on what savers stand to lose from their regular pay packet rather than how much they stand to gain in retirement.

“Auto-enrolment was a water-shed moment as it changed the dial from ‘do nothing, get nothing’ to ‘do nothing, get something’. Saving for retirement is no longer an option – it is an essential period of life to plan for as the state begins to tussle with the challenges of an ageing society.

“While there is lots of noise about the cost to consumers, auto-enrolment – even with the uplift in contributions – still offers people a return of nearly 350 per cent on their personal contributions thanks to a boost from their employer and tax relief.

“We cannot forget that auto-enrolment was always viewed as achieving the bare minimum for private pension saving, a baseline on which to build additional saving. Opting out come April 2018 will see a loss of valuable employer contributions that they, quite simply, cannot get elsewhere.

“Any short-term cost saving now will shrink in light of the valuable benefits you could have had later.”

Whether April sees employees sucking up the higher contributions or haemorrhaging from the scheme will finally show whether it has been a success – or not. And opinion is divided on what employees will do.

Younger and more vulnerable

“Typically, those opting out will be younger people, burdened with student debt with no idea how they’ll get on the property ladder,” warns Natalie Flood of the financial services firm Redington.

“For them, retirement is a long way away and difficult to think about in the context of their current financial needs. Others who opt out will be those on lower incomes or with stretched finances who can’t afford the drop in take-home pay.”

But she highlights that the actual contribution is still relatively small: “Following the increase, some people will notice that their take home pay is reduced and so we will see a small spike in the number of people opting out. In reality, when employee contributions increase from 1 to 3 per cent, someone earning the national average wage of approximately £26,700 per year will see take home pay reduce by around £30 per month.”

There’s certainly no shortage of people urging employees not to opt out, if they are willing to listen, and issuing grave warnings of the impoverished old age that awaits anyone planning to survive on the state pension.

Jamie Smith-Thompson, managing director at pension specialist Portafina, says: “I would strongly urge people to not even consider the options of opting out or opting down. If money is tight then look for anything else you could give up or cut down on, or do more cheaply before even thinking about reducing your auto-enrolment contributions.

“Unless you know absolutely for certain that you are going to be taken care of when you are older – a cast-iron guaranteed trust fund, for example – then it really is a no-brainer.”

Profitable lethargy

On the plus side, it’s entirely possible that our inherent lethargy will stop many people from going to the trouble of opting out. After all, the British are terrible at switching financial products even when there are significant gains to be made. Potentially we will be equally dreadful at going to the trouble of cancelling our enrolment.

Fidelity’s Jones certainly believes that. She says: “We do not anticipate a large increase in opt outs, many schemes already have contribution rates above the minimum level and opt out rates aren’t significantly different in those schemes than those who are at minimum level. Inertia will still play a big role in people remaining opted in.

In fact, she’s clearly sick of being asked about opt-outs: “Every time this policy goes into a new stage, there are noises about opt out rates soaring. When it was just big companies brought into the policy, everyone said we should wait for the small businesses. And now the Armageddon hasn’t arrived, attention now turns to the uplift in the rate.”

Still not enough

While 2 per cent is not enough to secure a comfortable retirement, the sad truth is that neither is 5 per cent or even 8 per cent.

Laura Myers, partner at LCP, says: “The stark reality is that even the 8 per cent contribution level which comes into effect next year is not even close to the recommended amount to save in order to have retirement security.

“It is imperative that no one is lured into a false sense of security that, just because they are auto-enrolled at a base level, they will have enough to live on in retirement – people actually need to save far more than that.”

Jones agrees: “We need to look at ways to increase retirement saving such as auto-increase of contributions, better engagement on what retirement income is required, etc. Ultimately however these can only go so far and at some point we will need to increase minimum contributions.”

Jasper Martens at PensionBee adds: “The only way savers will achieve an adequate pot is by contributing at least 10-15 per cent of their salary every month. This means that it’s vital to stay enrolled, and up your payments if possible.

“Savers, employers and the government need to go further – a 5 per cent monthly contribution isn’t going to prevent a pension crisis.”