Steve Webb's Pension Clinic: Going beyond the minimum pension contribution level can make a big difference to your standard of living in retirement.
We all like a bargain, and if you are anything like me, a nice ‘buy one, get one free’ offer in the supermarket is likely to catch the eye. But what many people do not realise is that the equivalent of a ‘buy one, get one free’ offer is available to millions of workers via their pension scheme – and many are failing to take advantage of it.
When you join a workplace pension, a decision has to be made about how much money you will put in and how much your employer will contribute. Under the automatic enrolment scheme there is a legal minimum, but most large firms will offer more than this. For example, it would not be unusual for workers in a big company to be contributing 4 or 5 per cent to their pension and for the firm to be putting in a similar amount.
But what is often not appreciated is that if you actively choose to contribute beyond the minimum level then your employer will do the same, up to a limit. So, for example, if you put in 5 per cent, the firm will put in 5 per cent, if you put in 6, your employer will put in 6, and so on up to some maximum level, say 7 per cent each. This would mean that instead of a combined 8 per cent of your pay going into your pension, a total of 14 per cent would go in.
Retirement income can be boosted by £3,000 a year
This could make a big difference to your standard of living in retirement. Royal London has calculated that someone who decides at age 40 to step up their contributions by 3 per cent per year and who benefits from an employer match could boost their income in retirement by over £3,000 per year.
It is worth looking at quite how good a rate of return this represents. When you put money into a pension, you get tax relief on those contributions. So, if you pay tax at the standard rate, the £1 you put into a pension costs you only 80 pence – the government gives you 20 pence back through a reduced tax bill.
For higher earners, that £1 could cost as little as 60 pence or even 55 pence, because they get tax relief at a higher rate. But an extra £1 going into a pension turns into £2 because of the matching contribution from the employer. So, for a cost of 80 pence (or less) you immediately have two pounds in an account with your name on it, accessible from age 55 or beyond, with a quarter available to be withdrawn tax-free. How many other investments can say that?
There are a number of barriers to people taking up this very attractive offer. Clearly some people will have competing priorities for their cash, and may have chosen to pay off debts or put money towards a deposit on a house. But many people may simply not be aware that their scheme offers these additional matching contributions. Or it may be one of those things that you always meant to get round to, but never quite had the time.
Moreover, some firms make it more difficult by only allowing you to change your contribution rate once a year, so if you miss the relevant ‘window’ you may have to wait another year before you can do anything. Given that employers have gone to the trouble of setting up such a scheme and presumably do so with the intention that workers should take advantage of it, much more could be done to make sure that people do actually take up what is on offer.
The scale of the problem is considerable. It is estimated that around three million workers who are employed by larger firms (who are more likely to offer this sort of arrangement) are not taking up their full entitlement. Each is missing out on an average of £650 per year in contributions from their employer. Particularly when there is much in the press about wage increases being depressed and people having little cash to spare, taking full advantage of ‘buy one, get one free’ contributions from your employer has got to be worth looking at.
Steve Webb is Director of Policy at Royal London
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