How much is enough on pension contributions?
Pension contributions have recently risen, but the increase may not be enough to fund a comfortable retirement.
The latest round of pre-planned increases to minimum contribution rates under automatic enrolment (AE) workplace pensions came into effect in April. If you are one of the 10 million peoplewho have been automatically enrolled, then broadly speaking, provided your yearly earnings are at least £10,000:
- Your employer must now contribute a minimum of 3% of your ‘band earnings’ into a pension (band earnings in 2019/20 are between £6,136 and £50,000); and
- You must make up the balance to bring the total contribution to 8% of ‘band earnings’.
The 8% total contribution figure is widely quoted, but the fact that it does not apply to all earnings is often overlooked. For example, based on the Office for National Statistics’ latest (February) estimate of average pay of £528 a week (£27,508 per year), the true AE contribution is approximately 6.2% of total pay. There are similar effects across the pay scale.
In the foreword to a Department for Work and Pensions report on the future of AE pensions, published in December 2017 , the then Secretary of State for Work and Pensions said, “…we recognise that contributions of 8 per cent are unlikely to give all individuals the retirement to which they aspire”. His proposals included:
- Removing the lower limit on ‘band earnings’, so that the 8% was based on full earnings (up to £50,000);
- Reducing the minimum age for inclusion in AE from 22 to 18; and
- Encouraging savings above the 8% level.
Eighteen months (and two new Secretaries of State) later there have been no further developments. AE contribution increases in both April 2018 and April 2019 may well have encouraged the government to pause, if only to see the reactions of employees.
How much to contribute?
So how much should your pension contributions be?
As far back as 2005, the Pensions Commission acknowledged that the state pension with additional AE contributions of 8% would only provide around half the level of savings needed for most people to enjoy an adequate retirement. The implication is that contributions should more than double for the average employee. But how much should your contribution levels increase? The amount will depend on several factors including:
- When you plan to retire and whether that is before you reach your state pension age:
- Your existing level of pension savings, including state benefits;
- Other savings on which you can draw in retirement; and
- Any limits imposed on you by the pension annual and lifetime allowances.
The calculation can become complex very quickly, so why not ask us to carry out an assessment of what your personal contribution rate should be?
The value of your investments and the income from them can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.
The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice.
The information in this article does not constitute advice and should be used for informational purposes only. This content has been provided to Helm Godfrey by Taxbriefs.