Why April is the month for a pay rise and a pay cut
New pension opt-in rules mean that you may take home less but you get future benefits for your old age
Congratulations and commiserations. If you’re an employee aged 22 or more, earning over £10,000 a year, you’ve likely just had a hidden pay rise and a hidden pay cut at the same time.
This may sound a bizarre possibility, but it is all about the pension auto-enrolment law. This says every firm must automatically opt-in all employees (aged 22-plus, earning at least £10,000) to saving from their salary towards a private pension – to provide money for later life – on top of the state pension. And the rules say if you are paying in, your employer must contribute too.
In other words, if you do nothing, you’re saving for a pension. And for the new tax year, which started on 6 April, the minimum amount that you and your employer must contribute has increased substantially.
The effect, which you will see for the first time in your April payslip, is a bit of a mind twist...
Everyone who is opted in effectively gets a pay rise... as your employer is giving you more money you wouldn’t have got otherwise, even though it’s not immediately usable.
Everyone who is opted in gets less take-home pay. To get the extra money, you will have to contribute more; so your disposable income – the amount you can spend each month – is reduced.
If your company gives you a pension, where what you will get is based on the number of years you work and your final salary, that’s a different scheme, so ignore this, it doesn’t apply. You could be paying three times what you were before. The new tax year saw two main changes: 1. The minimum your employer has to contribute has increased from 1 per cent of your salary to 2 per cent (so £200 a year per £10,000 salary).
2. The minimum total contribution from you and your employer together has risen to 5 per cent from 2 per cent. For someone whose employer only offers the minimum, that means you were both paying 1 per cent, but now it’s paying 2 per cent and you’re paying 3 per cent – in which case you’ll see your contributions triple.
This is helped a little by tax changes this year which mean most people will take home more on the same wages (use the www.mse.me/taxcalc tool to see). Plus, if you’re a graduate you may be about to pay far less back on your student loan. See my new www.mse.me/ Studentchange blog for why.
It’s worth noting some employers have much more generous schemes, in which case these minimums are irrelevant and you may not see a change. The gain here is unbeatable. Pension contributions are from pre-tax salary. So a basic 20 per cent rate taxpayer (someone earning roughly between £12,000 and £46,000), having £60 a month put in their pension, only sees their pay packet reduce by £48, because it would’ve been reduced to this by tax anyway (higher-rate taxpayers only see a £36 reduction).
Plus, for the first 3 per cent you put in, your employer has to put in at least the minimum 2 per cent. That means, even with the minimum contribution, for every £60 you put in, your employer would put in £40, so there’s £100 added to your pension that only costs you £48 (£36 at higher rate).
If you’re struggling, the thought of more money coming out of your salary may make you want to opt out or reduce contributions. Do try to avoid that if at all possible, it would mean you’re effectively giving up extra money from your employer.
If possible, increase your contributions so you get your employer’s maximum – the more you save now, the less likely a retirement on cold baked beans.
There are a few decent reasons for opting out though, if you’ve got very expensive debts to repay, you’re near retirement and have very little savings (in which case a bigger pension can reduce benefits) or you’re lucky enough to be close or at the lifetime pension £1m allowance.
Just to show you how important saving for retirement is, there’s a very (very) rough rule of thumb that shows how much you should put in your pension so you can retire on two-thirds of your final salary.
Take the age you started your pension and halve it then put this percentage of your salary in each year until you retire (including your employer’s contribution). This means that someone starting aged 20 would need 10 per cent, aged 40 would need 20 per cent.
Of course, for most people these amounts are a fantasy, so don’t get too hung up on it. Instead just use it to realise that, a) the sooner you start the better, and b) put in as much as you can afford.
My final trick to boost your pension contribution, if you’re lucky enough to ever get a pay rise – immediately put a quarter of the new money towards your pension.
That way, because you’re not used to earning it, you won’t miss it as much (I call this the forgotten gold technique!).