Financial pressure from the cost of living crisis is causing many to look at their finances and question where they can cut costs. One way workers believe they can increase the money in their pocket each month is to leave their company pension scheme.
In fact, a recent report from Money Marketing revealed that 45% of businesses with more than 500 employees had seen workers leaving pension schemes. And 40% revealed that some employees were opting to reduce their contributions.
More recently, the financial fallout from the government’s mini-Budget and various ensuing U-turns has raised fears over the security of pension savings. This, of course, could also lead more people to reduce or stop contributions.
Short-term thinking is putting workers’ financial futures at risk
The problem with this short-term thinking is that people are putting their financial futures at risk.
Stopping or reducing pension contributions, even for a brief period, could lead to a significant shortfall in retirement income and lead to longer-term financial struggles.
During the current crisis, one way to reassure and support employees is to help them understand their workplace pension. Then, those considering opting out or reducing their contributions will be making more informed decisions.
3 questions employees might have with answers to help guide your response
Question 1: How much goes into my workplace pension?
Answer: Under current rules, as of October 2022, the minimum total contribution that must go towards your workplace pension is 8% of your salary. This generally comprises three elements: your (employee) contributions, employer contributions, and tax relief.
Employee contributions
You must contribute at least 5% of your salary into your workplace pension. This money is taken directly from your pay each month.
It’s also possible to pay extra and you can choose to make voluntary contributions into your pot. Some employers may choose to match additional contributions.
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Employer contributions
Employers must contribute a minimum of 3% of your salary into your workplace pension, but this is not a maximum threshold. Some employers choose to pay more as an incentive to attract workers.
There are also tax advantages for employers paying more into employees’ pension funds. You should be ready to consider if your business could benefit from supporting workers by matching or “double matching” employee pension contributions.
There are advantages to increasing employer pension contributions. If this is something that you’d like to find out more about, please get in touch and we can help you understand the business benefits of doing so.
Tax relief
Pension contributions also receive tax relief. Tax relief removes the Income Tax that you would have paid on your salary and adds it into your pension pot at your marginal rate of Income Tax.
In real terms, this means that for basic-rate taxpayers, a £100 contribution into your pension only costs £80.
For higher- and additional-rate taxpayers, a £100 contribution costs £60 and £55 respectively.
Tax relief makes up the final 1% of the compulsory 8% but, depending on your marginal rate of Income Tax, you may receive more than the basic 20%.
It’s important to note that there is a threshold for how much of your contributions you can receive tax relief on. This is called the “Annual Allowance”. In the 2022/23 tax year, the Annual Allowance is £40,000 or up to 100% of your salary, whichever is lower.
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Tax relief is typically applied through an adjustment to your tax band.
And remember, when you retire, the first 25% of your pension can normally be taken as a tax-free lump sum, with the rest liable to Income Tax at your marginal rate.
Question 2: Do you offer salary sacrifice?
Answer: Sacrificing some of your salary in return for greater pension contributions from your employer can give your pot a boost. This can be particularly useful if you’re getting close to retiring and no longer need the whole of your salary for income.
Salary sacrifice can also have National Insurance (NI) benefits. Because pension contributions paid through salary sacrifice do not form part of your pay packet, they are typically free from NI charges. This benefits both you and your employer.
Bear in mind that salary sacrifice could have a wider impact on your financial health. For example, your mortgage eligibility may be partially calculated from your annual salary. So, if you choose salary sacrifice and reduce your annual earnings, it may affect the amount you can borrow.
This could also affect any protection policies you have. For example, if you have an income protection policy, your insurer will work out how much you’re owed from your gross salary and won’t include any amount that you sacrifice. This could mean you receive less from your protection cover if you ever had to rely on it.
Question 3: Can I opt out of my workplace pension scheme?
Short answer: Yes – but think carefully before you act as stopping or pausing your pension contributions could mean you won’t have enough income in retirement.
Detailed answer: Although employers must offer a workplace pension scheme, you’re entitled to opt out and take your contributions as salary instead.
If you opt out within one month of being enrolled, your contributions will be returned to you. Opting out after this point will mean you won’t be able to access those funds until retirement.
However, bear in mind that by opting out, you won’t receive employer contributions, tax relief, or the potential investment returns that your workplace pension offers.
Think hard before making any decision and, if in doubt, seek financial advice before you stop paying into your pension.
A recent study from Standard Life found that reducing or stopping pension contributions could have a significant effect on the value of a pension pot, even after a relatively short period of time.
The pension provider calculated the value of a pension pot based on the holder earning £25,000 a year and making monthly contributions of 3% from the age of 22. It also assumed that these contributions were boosted by a 5% contribution from their employer.
In this scenario, the pension pot would be worth £456,893 when the pension holder reached the age of 68.
However, if pension contributions were stopped at the age of 35 – for just one year – the value of the pension pot would drop to £444,129, almost £13,000 less than if contributions had continued.
If contributions were stopped for two years the pension pot could be reduced by around £25,000, and if contributions were postponed for three years, it could be reduced by nearly £38,000.
These calculations were based on an average investment growth of 6.25%, salary growth of 3%, and annual inflation of 2%. It also assumed annual investment costs of 1% a year.
LEBC are here to provide additional support to you and your employees
There are a number of other important things to take into account when it comes to pension saving in difficult times. To find out more you can request our free guide:
We also provide truly independent consulting services covering every aspect of workplace pensions. We can assist you in setting up and implementing a workplace pension and help ensure you are achieving “Good Member Outcomes” for employees in your scheme.
We also make sure that your scheme is compliant with legislation and aim for you and your employees to get a healthy return on investments.
Our fresh approach to pension consulting supports employers in delivering high quality workplace schemes to their employees in a clear concise and engaging manner. And our experts are on hand to advise your employees on the most efficient ways to build their pension pot and help improve their financial wellbeing.
Get in touch
If you would like to discuss any aspect of your company pension scheme and how to support employees during the cost of living crisis, please get in touch.
Email: clientenquiries@lebc-group.com or call us on 0800 055 6585.
Please note:
This article is for information only and does not constitute financial advice or a recommendation to any investment or retirement strategy. You should seek professional financial advice before embarking on any course of action.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
Workplace pensions are regulated by The Pension Regulator.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.