As many as one-in-three workers could be throwing tens of thousands of pounds away. Don’t make the common mistake of not opting-in to a company pension scheme.
Many employers operate occupational pension schemes open to their workforce, usually after an initial period of qualifying employment. Partly because of the fact that you get an offer to join long after you’ve started the job and partly because of confusing pension jargon, many people just ignore the offer.
Under our complex system of regulation, employers can’t give people advice about their pensions, so if you don’t respond to the bits of paper they send out, nobody will pull you aside and whisper in your ear: ‘It’s free money, you know’.
Actually, that’s not quite true. If an employer offers to contribute to your pension, the amount they pay is certainly factored into the salary on offer, in the same way as other costs like company cars. But once the employer is offering a contribution, then not joining their scheme is turning down free money and is likely to represent a really bad financial decision.
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Click here for a free SIPP consultationWhat goes into the work pension pot?So let’s consider the case of Joe Public, who at the age of 25 has landed a job at £26,000 a year with Bloggins Ltd, which runs a ‘defined contribution’ pension scheme for its employees. If Joe joins, he pays in 4% of his earnings and so does Bloggins.
Joe can put in more if he wants to, but Bloggins will only pay in its 4% and no more. Pension contributions qualify for tax relief, so Joe gets not £1,040 (£26,000 X 4%) docked from his pay but £811.20 (£1,040 less 22% tax), and the scheme itself collects £228.80 from the Treasury, plus the £1,040 from Bloggins. (Actually the figures are more complicated than this, but let’s try and keep it simple).
Now let’s make the ridiculous assumption that Joe works for Bloggins until he retires at the age of 65 (by the time Joe retires, it will be 68 but let’s pass on that one, too). Now of course Joe’s earnings will increase, and this is where it can all go pear-shaped trying to understand what’s going on.
The
calculator endorsed by the Financial Services Authority assumes that Joe’s earnings rise at 2.5% a year, but so do prices, and that means we can ignore changes in Joe’s money earnings and just think in terms of today’s money values. It also assumes that the contributions will earn a return of 3% a year on top of inflation (which I personally say is conservative, but in the interests of simplicity we’ll let this one go as well).
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Click here for a free SIPP consultation£42,000 tax-free cash at 65Punching in the figures- Joe contributes £68 per month, Bloggins contributes 4% of his salary - it turns out that at age 65 Joe will get a tax-free cash sum of £42,000 and a pension income for life of £169 per week. Those figures are not ‘funny money’ but are in today’s spending power.
I don’t think this is always a helpful way of putting it, and what Joe should focus on is the actual capital value of his pension fund - which is his fund, with his name on it, spendable only by him or his dependants.
At age 65, the value will be £168,000, and the key point is that of that sum, £84,000 will have come from Bloggins’ contributions. So, in terms of his lifetime employment, saying no to Bloggins’ pension offer would cost Joe £84,000.
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Click here for a free SIPP consultationAutomatic enrolment after 2012Now of course Joe will in reality change jobs many times, but after 2012 every employer he joins will automatically opt him into its pension scheme, which will be at least as good as what I’ve assumed above in terms of total contributions.
There are some uncertainties ahead over how the new national pension system will work after 2012, and I’ve already warned that under the current rules those on low earnings should think long and hard before paying into pension plans.
I hope you haven’t said no to the offer of free money from your employer, but if you have, most allow you to change your mind. If your situation is like Joe’s, it’s pretty clear what you should do.
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