Pension rules mean you could end up with £90,000 less in retirement

The way that auto-enrolment rules work means contributions aren’t based on your whole salary - so you’ll miss out of thousands of pounds

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You cannot believe what you hear about workplace pensions, because the way they are calculated could mean you end up with far less than you expected. The experts have identified a problem with workplace pensions which were established as part of 'auto-enrolment' rules brought in two years ago. They calculate that this could leave people more than £90,000 worse off in retirement than they expect.

Auto-enrolment was meant to put a stop to the problem of people getting to the end of their working life without ever having joined a workplace pension scheme - leaving them utterly reliant on the state. The rules automatically sign up everyone earning enough money to pay tax (currently £10,000) - so they automatically make a contribution - and their employer makes a contribution too. Anyone can opt out of this scheme, but the idea is that most people can't be bothered, so will end up with a pension.

The scheme has been introduced gradually, so that at the moment people are only having a grand total of 2% of salary paid into their pension. However, we have been regularly told that eventually (in four years) the combination of our employer and us contributing will rise to 8% of salary, which should be enough to make a difference to our lifestyle in retirement.

Confusion

The problem is that this isn't entirely true. The contributions won't be based on your entire salary - but on what is known as 'qualifying earnings'. This means that only the sums you earn between £5,772 and £41,865 are counted.

NOW Pensions did the calculations, comparing the contributions made on 'qualifying earnings' with the contributions that would be made if every penny of earnings was counted. They found that someone earning an average salary of £27,000 would actually have contributions of up to £90,500 less than they were expecting by the time they retire (assuming they pay into a pension for 40 years).

Chief executive Morten Nilsson said: "The 8% contribution rate is regularly quoted but the reality is nobody will actually get a full 8% – the most anyone gets is 6.9% if they are exactly at the top of the earnings band, with somebody earning £10,000 only receiving a total contribution of 3.4%, which is woefully inadequate."

He adds: "Removing band earnings and basing contributions on all salary would help boost savings for all and would remove a great deal of the administrative complexity for employers."

Tim Sharp, Pensions Policy Officer at the Trades Union Congress, agreed: "For auto enrolment to live up to its potential to provide low and middle earners with good incomes in retirement, we need minimum contributions to go up in stages beyond current plans. We think there is a strong case for employer contributions to be paid on every pound of earnings."

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Brian Gaffney on Behavioral Finance Research in Retirement Planning


What can you do?

Tom McPhail, Head of Pensions Research at Hargreaves Lansdown believes that even if 8% of our entire salary was contributed, it still wouldn't be enough to secure a comfortable retirement. He says that contributions of 12% or more are the bare minimum for a comfortable retirement. Advisers at Towry suggest that higher earners should be looking to save closer to 15% of their salary into a pension.

It means that, yet again, we learn that we cannot rely on legislation to keep us out of financial difficulty in retirement. The only way to secure a decent pension is to take control of our own future, work out what we need to save, and how much we need to contribute to ensure we get there. Because whatever you end up contributing to your pension, you can be sure that it has to be somewhere a long way north of 2% of your salary if it's going to buy you more than an extra slice of toast every month in retirement.

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