Should I join my employer’s pension scheme?
The simple answer is an emphatic, “Yes!”. Dire Straits sang about, “money for nothing” and that is precisely what your employer’s pension scheme is. Okay, in most schemes you contribute, but those contributions trigger contributions from your employer which you won’t get if you don’t join.
There are two broad types of workplace pension, as follows:
Money Purchase or Defined Contribution (DC) Pension.
This is now the most common form of workplace pension and involves regular contributions, generally linked to the frequency that payday recurs, invested into a fund. You, as the member, take all the investment risk whilst building up a fund to provide an income in retirement.
Defined Benefit (DB) Pension.
A DB pension is expressed as a level of income payable at Normal Retirement Age. That pension may be backed by an investment portfolio with which the employer is assuming all the investment risk.
According to the Pension Protection Fund in February 2023, there were just 1,013 Final Salary pension schemes left, down from a peak of some 6,400. The open-ended nature of the investment risk placed upon employers made Final Salary schemes for most untenable. The majority of open DB pensions, including all the public sector schemes, are now Career Average Revalued Earnings (CARE) schemes.
Autoenrolment Pension
The most common form of DC pension is known as Autoenrolment and was introduced by the Government in 2012. The aim was to increase pension savings by workers following the failure of the previous Stakeholder scheme which was introduced in 2001. The key difference is in the name – Autoenrolment – with the Stakeholder scheme employees opted in whereas, with Autoenrolment, it’s an opt out. If you opted out, you will automatically be re-enrolled every three years.
Autoenrolment has been successful in achieving the aims of the legislation; in October 2022, the Government reported that, in real terms (i.e., inflation adjusted), pension contributions had increased from £41.5bn per annum in 2012 to £62.3bn in 2021.
Autoenrolment Pension Rules
The basic rules are:
- Anyone between 22 and State Retirement Age earning £10,000 per annum or more must be autoenrolled.
- Any one between 16 and 21 can ask to join, as can anyone between State Retirement Age and 74
- Contributions are 8% per annum – 3% employer; 5% employee of earnings between £6,240 and £50,270 (Tax Year 2023/24)
The full rules are available from the Government’s website.
A Private Member’s Bill received the Royal Assent on 19 September 2023 which reduces the minimum age from 22 to 18 and takes away the lower earnings threshold. It is expected these changes will be phased in over the three years or so following passing of the Bill.
How should I invest in my DC pension
This is the $64,000 question.
What I can probably say with confidence is that, if you are a member of a DC pension scheme, particularly an Autoenrolment scheme, you’re probably invested in the wrong Fund! Statistics from 2021-22 from The Pension Regulator show that:
“Almost all people saving in a workplace pension scheme are invested in the default fund of their pension scheme and have not personally chosen how their pension is managed or invested. For most pension savers, engagement with pension products and financial literacy is very low.”
The “default fund” is, by definition, a one-size-fits-all approach to investment which is unlikely to be right for you depending on where you are on your journey to retirement. If you are at the beginning – a teenager or in your early 20s – you have half a century until you can access your savings, so what does the short-term matter? Conversely, if you are in your 60s and closer to retirement, the short-terms matters more, as you have less time in which to turn losses into gains.
Pension Fund Investment Risk
The following chart tracks the performance of two investment sectors – the Mixed Investment 40-85% Equity (representing the higher risk approach) and 0-35% Equity (representing the lower risk approach). There’s an enormous difference in the outcomes at the end of 20-years. The only difference is the volatility (up and down share price movement). As I’ve said, if you can’t access the savings, what difference does this volatility make?
Do you have access to advice on how your pension is invested?
Your employer will be taking professional advice on setting up and running their DC pension, but does that organisation offer advice to you as a member on how to effectively invest your contributions? If not, introduce me to your HR/Pension Department so I can explain to them how I can help.
What’s next?
If you are anywhere on the journey to retirement, from beginning to end, talk to me about how we can exploit all the current pension rules to your advantage.
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0800 074 8755info@clivebarwell.co.uk