Everyone knows that they should be saving for retirement, but figuring out how best to build up your pension pot can feel complicated – and a little scary. At Starling, our mission is to give you the tools to live a healthier, happier financial life, and part of this is helping you to save for retirement by exploring the benefits and debunking a few myths.
Six years ago, the government rolled out auto-enrolment retirement schemes. Auto-enrolment means that employees are automatically put into their workplace pension scheme – a scheme that you opt out of, rather than initially opting in. It initially applied to businesses with at least 250 staff, and this year it reached an important landmark as it was extended to all employees, even those in the smallest workplaces.
Nudging the nation
Barely a week goes by without alarming headlines about the “pensions gap” and the problems millions could be facing. The survey published by the Financial Conduct Authority (FCA) in October 2017 found that about 15 million people, 31% of British adults, have no pension savings at all, and will have to rely on the state pension. This currently sits at £125.95 a week for those who retired before April 6 2016 and £164.35 for those retiring after that date.
Eye-opening statistics such as these prompted the then Coalition Government to introduce auto-enrolment. A theory popular with advisers to David Cameron stated that people could be “nudged” towards making good choices in many different fields, from nutrition and exercise to retirement saving.
Staying in auto-enrolment
Currently, only about 10% of employees have chosen to opt out of these pension schemes, although some expect this to increase sharply after minimum contributions are raised.
The big incentive to remain in auto-enrolment is the attraction of “free money”. Currently, employers pay in the equivalent of 2% of “qualifying earnings.” You pay 2.4% into your pension, and the Government will give 0.6% in the form of tax relief. The rules apply to “qualifying earnings”, defined as those between £6,032 a year and £46,350.
As of April 2019, the employer’s contribution will rise to 3%, the employee’s contribution to 4% and the tax relief to 1%.
It is this increase that has led some to fear that opt-out rates could surge next year. However, a more optimistic view would hold that the pension savings habit may be sufficiently ingrained after six years of auto-enrolment to stem the numbers throwing in the towel. Let’s hope so: the idea that some people “can’t afford” to make pension contributions is one of many myths around pensions. The truth is that most can’t afford not to.
It's never too early to start
Another myth is that young people can cheerfully postpone pension saving until a later date. But let’s have a look at this from the perspective of a young graduate.
Imagine you’re a 25-year-old working for an employer with an auto-enrolment pension scheme. You’re considering opting out of the scheme for five years, believing the modest amounts you would contribute early in your career from a starting salary would make little difference to your final pension. You expect to be working for another 40 or so years so surely 5 years is a small slice?
But if you opt out for five years, this delay could reduce your eventual pension payout by up to 30%. Figures based on research by Guided Outcomes and Hymans Robertson were quoted by Money Advice Service (MAS): “To have an income of £20,000 a year in retirement, you would need to put aside roughly £250 a month from the age of 25. Wait until you’re 35, and this figure goes up to a little more than £400 a month.”
The earlier you start, the earlier you reap the rewards of retirement saving: the employer contribution, the tax relief and the chance to build up a meaningful pot for later life.
It’s also not too late
The “too young to worry” myth is not the only age-related misconception around pensions. Many people also worry that it is “too late” to start saving for retirement. According to the FCA survey mentioned earlier, 32% of adults aged 50 and over answered that the reason for this was that they thought it was too late for them to start one. But very often that’s not the case.
This time, imagine you’re a 55-year-old without any pension provision and you think it’s too late to start. But the moment you starts putting money aside, you benefit from the tax breaks – 20% tax relief for basic rate taxpayers on the first £40,000 paid into a pension each year. That means some of the tax you’ve already paid is refunded and added to your contributions.
This relief, as we have seen, occurs automatically in workplace pensions and, if you’re in such a scheme, you’ll also immediately benefit from your employer’s contribution.
Even with these tailwinds, you may prefer to keep working beyond the normal retirement age in order to build up a more substantial pot. But here, you would be helped by UK equality legislation, which prohibits employers from enforcing a default retirement age unless it can be objectively justified.