Why Pension Inaction Matters for Young People

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The State Pension can provide a basic income in retirement, but it is hardly enough to fund a comfortable lifestyle. Increases to the retirement age and cuts to the triple lock suggest that further erosions of the State Pension are not off the table.

Auto-enrolment was introduced to ensure that all workers had access to a pension, and that employers would pay their share. But 10 years on from its introduction, auto-enrolment is not fully covering the gaps, and many people are still suffering from pension inequality.

One of the problems is that anyone who is either under the age of 22 or earning less than £10,000 is not eligible to be auto-enrolled. In most cases they can choose to join their employer’s pension scheme, but this requires an active decision and most people simply do not prioritise their pensions. These factors alone are estimated to cost young workers £34,000 in pension funding^[1].

The government is considering plans to reduce the minimum age and earnings level, but progress is likely to be slow. In the meantime, there are plenty of things you can do to set your own retirement on track.

The Basics of Auto-Enrolment

The auto-enrolment rules are as follows:

•         All workers aged between 22 and State Pension age earning over £10,000 per year must be automatically enrolled into a workplace pension. They can opt out, but will be re-enrolled on a three yearly basis.

•         If you earn under £10,000 you can elect to join the scheme, but your employer only needs to contribute if you earn over £6,240 per year (or the monthly equivalent).

•         Contributions are calculated based on your earnings between £6,240 and £50,270.

•         Your employer contributes 3% of your earnings between these thresholds.

•         You contribute 4% and receive 1% in tax relief. This takes the total contribution level to 8%.

•         This means that someone earning £40,000 per year receives annual pension contributions of around £2,700. Assuming a 40 year working life, and ignoring pay rises or inflation, this could build up a retirement pot of around £430,000 (based on average investment growth of 6% per year).

•         Auto-enrolment is most beneficial for basic rate taxpayers aged over 22 who work full time in one job.

Who Needs to Take Action

While the auto-enrolment legislation goes some way towards bridging the retirement gap, there are a number of groups who are not covered, and could experience a retirement shortfall. For example:

•         Lower earners or part time workers.

•         Higher earners, for whom the basic minimum contributions may not be sufficient.

•         People who work in multiple jobs, as while they might earn a full-time equivalent wage, they are still below the threshold with each employer.

•         Those with caring responsibilities including stay-at-home parents.

•         The self-employed.

Of course, many lower earners simply cannot afford to contribute to a pension as their monthly budget is already stretched. But from the groups above, there are many people who can and should fund their retirement, but miss out on a technicality.

If this applies to you, you cannot rely on your employer and need to take control of your own retirement plan.

Planning Your Contributions

You do not need to be limited by your workplace pension and the auto-enrolment rules. You can make additional contributions or even set up your own personal pension which is completely independent of your employer.

If you own a company, your business can make contributions on your behalf.

The amount you contribute to your pension will depend on the following:

•         How much you can afford to contribute.

•         How much you need to live on in retirement.

•         How much investment risk you are prepared to take.

Most pension providers offer a tool to project different scenarios, helping you decide how much to contribute. Alternatively, Money Helper offers a free retirement calculator.

While you might not be able to contribute much in the early years, it is still worth building good habits and saving small amounts. Even £50 per month from your early 20s will significantly boost your retirement pot. Increasing your contributions every year is one of the most powerful things you can do to increase your retirement income and chances are you will hardly notice.

Investing Your Fund

Your pension provider will normally offer a default investment choice, but you should check if this is the best option for you.

If you are more than 10 years away from retirement, you should aim to invest mainly in equities. This offers the best chance of inflation-beating long-term growth. However, you should be prepared for lots of ups and downs as the market fluctuates.

As you progress towards retirement, it may be appropriate to incorporate some bonds and cash to stabilise your fund value. Unless you want to buy an annuity, you should still aim to keep some equity-based investments at retirement and beyond.

A lifestyle tracker fund can automate this process for you. It’s worth ensuring that the fund is aligned with your goals and chosen retirement age. If you plan to start drawdown income at age 70, a tracker that targets an annuity at age 55 will not be suitable for you.

Alternatively, you can select and review your own funds. You should consider:

•         The volatility of the fund and whether this matches your own attitude to risk.

•         The charges.

•         The performance of the fund compared with its peers.

If you are choosing investments for the first time, a passive multi-asset fund could be a suitable option. This offers returns in line with the market at a low cost.

Check Your State Pension

You should also make sure that you are on track to receive a full State Pension. Anyone who is working or receiving certain benefits should be earning National Insurance credits.

You need 35 years’ worth of National Insurance credits for a full State Pension.

If you are not working (and earning at least £6,240) or claiming benefits, you won’t be building up your State Pension. An example of this could be the partner of a higher earner who is not claiming Child Benefit.

You can check your State Pension entitlement here. If you have a shortfall, you might be able to make voluntary contributions to build up your record.

Regular Reviews

Your circumstances will change and your pension fund will fluctuate with the market. It’s important that you check your annual statement to ensure that your fund is on track.

You should receive annual projections from your pension provider to give an indication of the income you could receive in retirement. You can also ask them to project alternative scenarios, or use planning tools on the provider’s website.

If you are approaching retirement, have multiple pensions, or have a more complex financial situation, an independent financial adviser can help you make sense of your options.

Please don’t hesitate to contact a member of the team to find out more about retirement planning.