September 14, 2012 5:49 pm

Millions may opt out of company pensions

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The government has been urged to do more to promote retirement saving to high income earners after a pensions industry body warned that up to a third of staff could opt out of auto-enrolment schemes.

From October, some of the country’s largest employers will begin to enrol staff automatically who meet wage and age criteria into a workplace pension scheme. This is regardless of whether they are already saving privately for a pension.

By 2017, when automatic enrolment is rolled out fullyto all employers across the country, up to 9m workers are expected to be newly saving, or saving more, for their retirement.

The measure is part of the government’s efforts to tackle the estimated 11m Britons, or 40 per cent of working-age people, who are not saving enough to maintain living standards in retirement, with middle and higher income earners at the greatest risk of undersaving.

According to a recent government report, an estimated 40 per cent of those earning £31,000-£50,000 per year were not setting aside enough to keep up living standards in retirement.

Nearly half of those earning £50,500 or more, or an estimated 4.2m individuals, faced a big drop in living standards when they retire.

But many observers say pressure on household budgets and high levels of indebtedness will prompt many employees to opt out of their company’s scheme.

“Given that many in these income groups have suffered falls in their inflation adjusted income over the last few years, many will probably believe they cannot afford to make contributions at this level, particularly if the employer funds its contribution by cutting their pay,” says James Sumpter of Bestinvest, the independent financial advisers.

“This could lead to a high number of opt-outs.”

Warning for top earners

Top earners with big pension pots may inadvertently face big tax bills if they are automatically enrolled into a company scheme.

Advisers say that individuals who have already made full contributions to a private pension plan could face tax charges if additional payments from a company scheme push total contributions above the £50,000 annual allowance.

There could also be tax headaches for employees who have built up sizeable pension plans that have required protection against the effects of tax where the values of such plans are likely to exceed the latest lifetime allowance of £1.5m.

“I would recommend that employees check when they are likely to be enrolled into their employer sponsored scheme and make sure they are planning ahead so as not to be caught by any unforeseen consequences,” says Andrew James, advice policy manager with Towry, the independent financial advisers.

Others say certain groups will be under more pressure to quit saving. “Those returning from maternity leave or career breaks will no doubt have additional drains on their finances, so will pull out,” says Simon Kew, director of pensions with Jackal Advisory, an independent advisory company for the pensions industry.

Under automatic enrolment, people aged between 22 and the state pension age earning over £8,105 a year will be enrolled.

Employers will be obliged to top-up employees’ contributions, which means that workplace pensions will grow faster than if individuals were saving for retirement on their own. However, employers are not required to make contributions for earnings above £43,475.

From October, the total contribution level will be 2 per cent, with a minimum of 1 per cent coming from the employer, but in time this will rise to at least 8 per cent, with a minimum of 3 per cent coming from the employer.

“The employer’s contribution is really free money and the government is offering tax relief, too,” says Morten Nilsson, chief executive of NOW Pensions, a provider.

“My biggest concern is whether these benefits can be communicated well.”

In spite of the advantages of workplace saving, the National Association of Pension Funds (NAPF) estimates that the opt-out rate could be as high as a third of new joiners.

“One of the main reasons for opting out will be affordability,” says Darren Philip, director of policy with the NAPF. “We need the government to really sell the virtues of retirement saving.”

Whether the government needs to move to full compulsion to tackle pension undersaving is one debate. Another is the level of contribution; the general view is that a combined contribution level of 8 per cent (to be achieved by October 2018) is still not enough to provide a decent retirement income.

“As an example of the level of savings required, someone aged 25 earning £25,000 a year would need to save 20 per cent of their salary every year from now until aged 65 to generate a pension of 50 per cent of their final salary at the age of 65,” says Sumpter of Bestinvest.

Making the right investment choices once in a company scheme could also make a big difference to outcomes at retirement.

Several new providers of low-cost pension schemes, such as the state-sponsored National Employment Savings Trust (Nest), Now and The People’s Pension, are targeting the auto-enrolment market.

But advisers warn that these scheme can be less flexible.

“The main limitation for all of the three ultra low-cost providers is that they are run on a shoestring,” says Laith Khalaf, pensions investment manager with Hargreaves Lansdown, the IFAs.

“This is good from the point of view of charges, but has drawbacks; they only offer a small range of predominantly passive funds.”

Comparing pension offerings
Pros Scheme Cons
Public service obligation to take all comers
Has implicit government support
High profile
First to launch – it has a head start
It has put thought into its proposition, including canvassing opinions from its target market.
National Employment Savings Trust logo
Cap on contributions at £4,400 per annum and no transfers into or out of Nest
Untested admin and investment strategy
15-year de-risking or lifestyling process. Is this too long?
Foundation phase means investing cautiously when investors are young.
 Good investment record for last five years
Experience of running pensions, though in Denmark
50 per cent of profits made by Now will be spent on improvements for scheme members.

NOW: Pensions logo
 Only one fund option
No ethical or shariah funds
Its investment strategy is very sophisticated and has done well over the past five years, but it is a cautious fund and is untested in a risky environment.

Has run high-turnover, low-value pension pots for the construction industry for decades.  
The People's Pension logo
 Its fund range uses static asset allocations. Given market volatility, this approach looks a bit dated.

Nick Rudd, head of corporate benefits with Broadstone Pensions & Investments, says if Nest is used across the whole workforce, middle and higher income earners could become “disenfranchised”.

“Nest is aimed at lower income employees and there is a degree of inflexibility with Nest,” says Rudd. “For example you have no investment choice. As a general rule you can’t transfer in or out of Nest and there is a maximum contribution of £4,400 per annum.”

Workers can opt out at any time but will only have their payments refunded if they do so within the first month.

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