What is Automatic Enrollment?

With a burgeoning ageing population that is heavily reliant on State Welfare, the UK government has introduced new reforms in which employers will now eventually have to offer a workplace pension scheme and enrol eligible workers in it.

This is called Automatic Enrollment, and it has been introduced to help people save more for their retirement.

The new system is being introduced in phases, and by 2018, all employers in the UK will have to comply with it.

While earlier, it was a matter of choice, it has now become a legality to comply with, for employees and employers.

If your financial situation does not allow paying towards an employee pension scheme, do you have a choice?

Here are some facts about Automatic Enrollment.

When will you be automatically enrolled?

As mentioned earlier, the rule is gradually being implemented. The largest employers in the UK (more than 120,000 staff) were the first ones to introduce the new rule. The medium-sized employers are now following suit. The small-sized employers will be the last ones to introduce it. In fact, Auto Enrollment has also been extended to companies with fewer than 30 people.

Depending on what category your employer belongs to, you can expect to be automatically enrolled somewhere in the next three years.

You will be informed about the exact date by your employer well in advance allowing you to plan out your finances accordingly.

The entire system is being governed by the Pension Regulator to ensure that workers are introduced at the right time.

The Eligibility for Automatic Enrollment

According to the new system, any person working in the UK above the age of 22 but under the State Pension Age who earns more than £8,105 annually will be eligible for automatic enrollment.

Workers who earn lesser or who work part-time can request to be enrolled. If they earn more than £5,564 annually, then their employer will also have to make a contribution towards their pension scheme.

If you are employed but above State Pension Age or below the age of 22, then you can still choose to opt-in your employee pension scheme.

Do you have a choice?

Yes, You do. You can read our article, ‘What Are The Benefits of Automatic Enrollment?‘ to get an idea of what you will be getting or missing out.

Employees are given a letter informing them about the starting date for Auto-Enrollment, details about the scheme and the Pension Provider.

You can then request an opt-out form from the pension provider if your financial situation does not allow you to contribute towards an additional pension scheme.

If you opt out within one month of enrollment, then you will receive a refund of any amount that you may have contributed towards the scheme.

If you choose to opt out at a later time, then any amount that you may have contributed towards the scheme will remain in your pension pot until retirement.

Employers are required to re-enroll people who have opted out after every three years. So, even if you have opted out of the pension scheme, you will be automatically re-enrolled after three years. You will then have the choice to remain in the scheme or will have to complete the opt-out procedure once again.

But opting out deprives you of the employer’s contribution towards your pension and the government’s tax relief.

What will be my contribution?

Currently, only a minimum contribution of 0.8% of your earnings will have to be paid towards the workplace pension scheme.  The employer will add another 1%, and the government will add 0.2% in the form of Tax-Relief.

However, these amounts will increase in 2017 and 2018 to a minimum of 4% contribution by the Employee, 3% from the employer and 1% Tax-Relief by the government. This will apply to anything earned above £5,824 to a limit of £42,385 including overtime and bonuses.

The funds will be accumulated in a Pension Pot and depending on whether it is a Pension firm, a government-backed organisation or an Insurance company that runs the scheme, each worker will be given options on how they choose to invest these funds.

There will be high risk as well as safer options to choose from. In exchange for the investment services, the pension provider will levy an annual charge which will be taken automatically from the pot.

Despite it sounding like a pay-cut, a workplace pension scheme has a bundle of advantages. Opting out should be the last thing on your mind.

Need an advisor on choosing the right retirement pension plans? Read our article, ‘How to Select a Financial Advisor’.

Topping Up Your Pensions

With both tax-relief and tax-free growth, a pension contribution is the most attractive financial investment you will ever make.

But are you making enough contributions towards it to ensure that you retire with a substantial pension pot?

If you have an employer or workplace pension scheme, then you should remember that the minimum contributions are relatively low and it will not be enough to provide you with an income to lead a comfortable retirement lifestyle.

If you have a personal pension plan, the more you contribute, the more you retire with.

So, should you be contributing more towards your workplace pension or should you top up your state pension? Is an SIPP a better option for you?

Employer Scheme vs SIPP

Irrespective of whether you are trying to up your contribution or add an additional scheme, sticking to your workplace pension scheme makes more sense.

With the new auto-enrolment reforms introduced in 2012, your employer is obliged to make a minimum contribution towards your pension pot.

That’s free money for the taking. Additionally, you have the option of paying your bonuses into the scheme making it easy for you to top up when the opportunity arrives.

The only drawback is that some employer workplace schemes have limited fund options to invest in. And many times, you do not get the personalised attention or support you desire.

That’s where an SIPP can be advantageous.

It provides an investor better control over their retirement savings. There are a plethora of fund options along with equities to choose from. You get personalized attention; you can check valuations and even switch funds in a blink.

An SIPP is a great way to consolidate existing workplace pension schemes that you may have if you have switched jobs recently.

For example, if you have three different pension pots, one from your current employer and two from your previous ones, you can consolidate the other two with an SIPP.

But the extra functionality offered by SIPP comes at additional charges which are higher than the charges on personal or stakeholder pensions.

So, unless you are not adept at making independent financial decisions or do not have multiple pension pots to consolidate, an SIPP might not be the best choice for you.

Additional Voluntary Contributions

If you are the member of a final salary or defined benefit scheme, then any top-up contributions you make will go into a separate AVC plan.

This is akin to a money purchase plan which means, that the eventual value of the plan depends on how much you contribute and how the investments perform.

However, if the AVC is linked to your main defined benefit scheme, you can avail of your 25% tax-free cash lump sum from your top up contributions keeping your defined benefit pot untouched.

Tips to Top Up

While topping up a pension scheme is a desirable proposition, it is not always the most practical one, especially if your current financial circumstances do not allow it.

The rules for contributing more remain the same old tried and tested methods.

Spend Less: The lesser you spend, the more you save, and a part of that savings can be diverted towards your pension funds. Reassess your finances, track expenses, weed out unwanted expenses and find a way to squeeze in that little extra every month to contribute towards your pension top up.

Bonus Sacrifice: If you have a workplace pension scheme then a bonus sacrifice is a great way to top up your pension pot in a tax-efficient manner. For example, if you were to receive a £20,000 bonus, it would be taxable, and you will also have to pay National Insurance contributions to it. If you are a higher rate taxpayer, you could end up with as less as £11,600 in cash. On the other hand, if you decide to pay it into your pension via a bonus sacrifice scheme, it would be tax and NI contributions free. Also, it will help your employer save 13.8% NI savings and most employers are generous enough to pass it to you. So, instead of £11,600 in cash, £22,600 could be added to your pension pot instead.