The auto-enrolment requirement for employer pensions now means more people than ever have access to a company pension. But are you making the most of your benefits?
As long as you meet eligibility requirements for auto-enrolment, you should have a company pension. Paying in the minimum contributions each month is a step towards saving for your retirement. However, you could maximise your benefits by taking further steps.
Here’s how company pensions work – and how to get the most out of them for a comfortable retirement.
- Why you shouldn’t opt out
- How do company pensions work?
- What steps should I take?
- Phasing in your retirement
Before we look at pensions in detail, let’s get one thing straight first:
Unless you already pay into a private pension, you shouldn’t opt out of auto-enrolment.
Yes, when you’re on a low income it can hurt to see so much of your pre-tax salary taken away from you. However, you’re getting more money in the long run!
Paying into a pension means your employer MUST meet minimum contributions, too. So, you pay a minimum of 4% of your salary – and they’ve got to pay a minimum of 3% (as of April 2019).
On top of that, the Government adds money, too! You’re getting FREE MONEY for your retirement.
Paying into a pension at source – i.e., before you get your salary – is tax efficient, too. Everyone wants to pay less tax, right?!
Your pension contributions come off your pre-tax salary. If you chose to save the same amount in a cash ISA instead, for example, you’re paying tax on the money before it goes into your savings.
More than that, the returns on a cash ISA are so low, your money loses buying power over time. A pension pot – that you can’t touch until you’re 55 – makes the most of compound interest and greater returns, as well as the tax benefits on offer.
It’s never too late to join a pension plan while you’re still employed – but the earlier you do it, the larger your retirement fund will be!
There are two main types of workplace, or occupational, pension:
- Defined benefit in which the most common type is final salary, and
- Defined contribution, also known as ‘money purchase’.
DEFINED BENEFIT PENSIONS
Defined benefit pensions will guarantee a particular income every month in retirement based on how much you earn and how long you are with the organisation for.
If you get the opportunity to take a pension like this, snap it up. It’s the most generous pension type. As long as you make the contributions expected, it’s up to the employer to ensure they deliver on their promises.
It doesn’t matter how the pension investments fare, or how long you live in retirement: you get the agreed income.
DEFINED CONTRIBUTION PENSIONS
Unfortunately, defined benefit pensions get so expensive for employers to offer that many private sector employers prefer to use Defined contribution pensions.
You get to choose where that money is invested but there are no guarantees. When you retire you simply get whatever the pot is worth.
It’s up to you to decide how to live off it in retirement.
The first step is to find out what your employer offers.
If it’s a defined contribution scheme then, in some cases, the amount on offer from your employer depends on what you put into the scheme.
So, it’s worth considering how much you can afford to invest in order to take advantage of any extra free money. The more you can put in, the greater the final sum as it is made up of contributions from you AND your employer.
Some defined benefit schemes offer the chance to make additional voluntary contributions (AVCs). Some even match these contributions.
In a defined contribution scheme, the money you put in will automatically go into a default fund, unless you choose where you want your money to be invested.
The default fund is generally low-risk to protect everyone’s pension as far as is possible. However, it’s worth checking to find out where your money is invested. It’s your right to choose where you want your money invested.
Work out what you are due to receive
Next, it’s worth discovering the kind of company pension lump sum or income you can expect from your occupational scheme.
You should be able to get an overview of pension performance and its projected value from your employer.
Remember to factor in your state pension by getting a state pension forecast. It’s then worth using one of the free online pension calculators. It only takes a few minutes but gives you a good idea of what you’re likely to get.
What if I have a number of different company pensions?
Many people end up with several workplace pensions as they move employers through their career. It’s up to you to decide what you do with them: keep them separate, or transfer into one pot.
It’s easy to lose track when you’ve got several pensions. The Government launched the Pension Tracing Service to help you find forgotten pensions.
Consolidating your pensions into one (or two) pension plans might seem to make the most sense. However, you could lose valuable benefits if you do so. Make sure you check the benefits on offer for each pension plan before deciding to consolidate.
On the other hand, some pension funds come with huge maintenance and management fees. If your pot is fairly small, it may be worth transferring out of any plan that will eat into your savings over time. Putting several pots into one could save you significant fees and costs over time.
Examine how much cash you’re putting in
Once you have calculated what your current occupational pension will offer in retirement, along with your state pension, you will have an idea of the kind of income you can expect in retirement.
In most cases the initial sum will come as something of a shock, especially if you are in a defined contribution scheme.
But the key is not to panic and assume you will be stuck in work forever. Instead, it’s important to think carefully about how much more you can afford to put aside in a chosen scheme, how much longer you can work, and whether you can generate the income you need for a comfortable retirement.
If you’re already nearing retirement and worried about your final pension income, don’t panic. You’ve still got time to find ways to save and invest to boost your retirement fund.
Check out our article on How to Save When You’re 50+ and Broke for more information.
Many people don’t realise they can draw their pension before they leave work. This is a good way to start a phased retirement. You can also make the most of the tax-free 25% lump sum available by putting it into other investments (such as property) while you have time to reap the rewards.
The State Pension isn’t enough for anyone to live off, unless you want a Spartan retirement. It’s also not available until you’re aged 65.
That means if you want to retire earlier than 65, you could see a drop in your income until you reach State Pension age. Drawing your personal pension early gives you financial support before you turn 65.
Remember, however, if you’re still working and want to draw your pension, this could push you into the higher-rate tax bracket.
To sum up…
- Make sure you know and take advantage of the benefits of your current company pension
- Work out what you have
- Calculate how much more you need to invest
- Ensure the money you put in is being invested in a manner that suits your circumstances
- Consider how early you want to retire
- Make investment plans for your 25% tax-free lump sum available when you’re 55.