What Are The Benefits of Automatic Enrollment?

As the government began introducing automatic enrollment at workplaces across the UK in 2012, a lot of people didn’t know whether it was a boon or a bane.

The ones who could barely make ends meet or had a pre-existing list of priorities were the ones who felt the crunch the most.

Even though the initial minimum salary contribution is only 0.8% of the earnings, the numbers are all set to rise in the next couple of years.

A minimum of 4% of the earnings of eligible people will be deducted starting 2016.

Is this beneficial for an average worker as the government wants you to believe, or is it just a strategy to reduce the strain on the state?

What would be the impact on the pocket of someone whose financial circumstances do not permit a pay cut?

Why Auto Enroll 

A report by the Department for Work and Pensions in 2012 revealed that almost 900,000 employers in the UK offered little or no workplace pension benefits to their employees.

The numbers were staggeringly low in certain sectors like retail, real estate and construction.

With the state pension not nearly enough to live a comfortable retirement life, these employees faced the risk of facing an ‘income gap’ when they retire.

Factors like increased life expectancy and rising healthcare costs post a gloomy picture for people who do not have a retirement income plan in place.

With auto-enrollment, more workers will be entitled to a retirement savings scheme where employers will be obliged to make a minimum contribution too.

While it will not be enough to ensure that the ‘pension gap’ does not occur, it will still be an additional source of income which will prove to be invaluable in the retirement years.

Take the Free Money

Employers are now obliged to pay a minimum amount of money into a workplace pension scheme under the new reforms.

The actual numbers are:

  • Until 2017, the minimum contribution towards a workplace pension scheme is 2% (employees to pay 0.8%, employers pay 1%, and you get a tax relief of 0.2%)
  • In the years, 2017 to 2018, the minimum contribution will increase to 5% (employees will pay 2.4%, employers will contribute 2%, and you will get tax relief of 0.6%)
  • From 2018 onwards, the minimum contribution will be 8% (employees will pay 4%, employers will contribute 3%, and you receive tax benefits of 1%)

These are only the minimum contribution numbers. Both employer and employee can contribute more towards it.

That’s like free money for you if you were not enrolled in a workplace pension scheme before, or if your employer made negligible contributions towards it.

If you opt out, you may have to create a private pension scheme and bear the entire cost of setting it up.

Reassess your finances

If you are in your twenties or thirties, the chances are that your financial circumstances may not be at their best.

You may have debts to pay off; you may be planning to start a family or buy a house. In such a scenario, a forced pay cut does not sound like an ideal proposition. (You can opt out of it anytime)

But auto-enrollment is also a great way to get started with the savings habit.

It allows you to gauge the impact of a pay cut on your financial planning and the effect it may have on your lifestyle. That’s like testing the waters before you jump in.

If you can make little sacrifices today and stay enrolled in your workplace pension scheme, it may have a significant effect on your retirement income.

What you need to be aware of

Despite all the perks, the minimum contribution levels are still relatively low and you cannot rest on your laurels yet.

You may still have to take action and set up additional pension schemes or investment plans to ensure that you can match the lifestyle you dream of.

The only reason why you may want to opt out of auto-enrollment is if you have unmanageable debts and find yourself borrowing money at the end of every month.

In this scenario, your goal should be to get on top of your debts first.

Confused on how you should plan for your retirement? Get a clear picture of what your options are with our article, Planning for Retirement.

 

Pensions and Tax Benefits

If saving for your twilight years does not seem motivating enough then the government is certainly doing its part to make it motivating for you.

Saving in a pension is one of the best ways to build up a retirement income in a tax-efficient manner.

Funds that go into your pension are looked upon leniently by the taxman. But there are annual as well as lifetime limits on how much tax relief you can get.

It pays to plan smartly and choose your options correctly to ensure that you maximize the benefits.

Understanding Tax Relief

In the year 2015-2016, the HM Revenue & Customs (HMRC) provides tax relief on pension contributions up to 100% of your earnings. The upper limit is £40,000.

To simplify things, here’s an example.

  • If you earn £25,000 and you contribute £30,000 into your pension pot by adding additional income sources, then you will only get tax relief on £25,000 (100% of your earnings)
  • On the other hand if you earn £80,000 a year and put the entire amount into your pension pot, you will only receive tax relief on £40,000 (The upper limit)

While you are enrolled in a pension scheme, you can carry forward unused tax allowances from the past three years.

However, if you are enrolled in a Defined Contribution Pension, then according to the new Pension reforms introduced in April 2015, then your contributions can be reduced to £10,000 in some cases.

The Money Purchase Annual Allowance

If a pension scheme member chooses to flexibly access the funds in their pension pot, it triggers the MPAA or Money Purchase Annual allowance which in effect, reduces the annual allowance to £10,000.

This means, if you take the tax-free cash or withdraw funds from the pension pot, you will then receive tax-relief only on £10,000 or 100% of your earnings, whichever is lower.

The MPAA has been drafted to prevent abuse of the flexibility options that a pensioner has.

Some situations in which you may trigger the MPAA are:

  • If you start to make random cash lump sums from your pension
  • If you invest in an income drawdown scheme and start to utilize the income

However, the MPAA limit only applies to defined contribution pensions.

Personal Pensions

If you have enrolled in a personal pension scheme then your income is taxed before your contributions are made into it.

You are eligible to get tax relief on up to 100% of your annual earnings.

The tax relief is automatically applied if your pension provider adds a 20% relief to your pension pot (relief at source).

You can claim additional tax relief if you pay above the basic rate of tax which is 20%.

For example:

  • If you pay 40% income tax, you can claim tax relief on the extra 20%.
  • If you pay 45% income tax, you can claim tax relief on the additional 25%

This claim can be made via a self-assessment form at the end of each tax year.

Company or Workplace Pensions

If you are enrolled in a workplace pension scheme, then the tax relief applicable to you depends on the type of scheme. In most cases, you may not have to do anything and it will all be set up by your employer.

Additional Voluntary Contribution Schemes and Money Purchase Pension Schemes give you instant tax relief as the contributions to the pension fund are paid before the income is taxed.

If you have enrolled in a Salary Sacrifice Scheme, then you will not be eligible for tax relief. But, it allows you to save on income tax and your NI (National Insurance) contributions since you opt for a reduced salary in exchange for contributions to your pension scheme.

Stakeholder and Group Personal Pension Schemes work in the same manner as Personal Pensions do.

Tax Relief for Non-Tax Payers

If you do not earn sufficient income to pay income tax, you can still receive tax relief on any contributions you make towards a pension fund with an upper limit of £2,880.

The taxman will top this up with a 20% contribution making the total amount £3,600. Every penny you add to the pension fund above this amount will be taxable.