Workplace Pensions: What do you Give Up if you Opt Out?
Opt out of a workplace pension and you’re essentially walking away from “free money” – that is, employer contributions and tax credits from the government. Workplace pension rules are changing and stand to help workers save more for retirement. While enrolment is now automatic for most employees, you do have the option to opt out. But should you?
While in some circumstances it may make sense to opt out (perhaps you’re actively paying off debts, you prefer a different form of savings and investing, or you’ve hit the lifetime allowance, which is currently £1 million in most cases), it is important to know what you’re giving up by opting out.
When you contribute to a workplace pension, both your employer and the government contribute as well (through tax relief, in the government’s case, if you pay Income Tax). The minimum contribution rates will increase over the next few years, as shown in the following table. Please note that these contribution percentages apply to Qualifying Earnings only. Qualifying Earnings are generally calculated as basic earnings up to £43,000 a year LESS £5,824 (calculated before income tax and National Insurance contributions have been taken out).
| Dates^ | Worker Contribution | Minimum Employer Contribution | Tax Relief | Total Contribution | |
|---|---|---|---|---|---|
| October 2012 to March 2018 | 0.8% | 1% | 0.2% | 2% | |
| April 2018 to March 2019 | 2.4% | 2% | 0.6% | 5% | |
| April 2019 onwards | 4% | 3% | 1% | 8% |
The following chart illustrates how workplace pension contributions would increase from March 2017 for average pre-tax UK household income levels of £34,718 per year (assuming one bread winner in the household). You can see the contributions to one’s pension are not insignificant. From April 2019, the average UK household would give up around £1,150 a year in employer contributions and tax relief. By opting out of your workplace pension you will not receive these contributions to help with your retirement.
To better understand how these contribution percentages affect your own retirement pot, we’ve calculated the contributions for 2019 and beyond in pound terms according to different income levels. The following chart gives a general idea of how much you may miss out on by opting out of the workplace pension, depending on how much you earn, and broken out by contribution type (i.e., your contribution, your employer’s contribution and tax relief). In the interest of understanding long-term impact, we’ve used the higher contribution percentages for April 2019 and beyond.
It is perhaps useful to see the actual pound values of workplace pension contributions by type, according to increasing income levels. The table below illustrates the contributions you’d put away for every £5,000 of earnings. Notice that those earning about the upper limit of £43,000 receive a capped benefit.
| Pre-Tax Income | Qualifying Earnings | Your Contribution | Employer’s Contribution | Tax Relief | Total Annual Contribution |
|---|---|---|---|---|---|
| £10,000 | £4,176 | £167 | £125 | £42 | £334 |
£15,000 | £9,176 | £367 | £275 | £92 | £734 |
£20,000 | £14,176 | £567 | £425 | £142 | £1,134 |
£25,000 | £19,176 | £767 | £575 | £192 | £1,534 |
£30,000 | £24,176 | £967 | £725 | £242 | £1,934 |
£35,000 | £29,176 | £1,167 | £875 | £292 | £2,334 |
£40,000 | £34,176 | £1,367 | £1,025 | £342 | £2,734 |
£45,000 | £37,176 | £1,487 | £1,115 | £372 | £2,974 |
£50,000 | £37,176 | £1,487 | £1,115 | £372 | £2,974 |
£55,000 | £37,176 | £1,487 | £1,115 | £372 | £2,974 |
If you want to calculate the contributions for your exact earnings, the Workplace Pension Calculator from the Money Advice Service is very helpful.
It’s true that by contributing to your workplace pension, you’ll have less take-home pay to use for living expenses or other savings and investing on a year-to-year basis. However, the hope is that your pension contributions will grow over time, benefiting from the power of compounding. (Plus remember the contributions from your employer and tax relief that you wouldn’t otherwise get.)
We are by no means predicting the returns you will earn on your pension (you could make more or you could even experience negative returns), but for the sake of illustration we have calculated how a workplace pension pot would grow if you contributed for 20 years, assuming an annual pre-tax income level of around £34,000 and investment returns of 3% per year.
To reiterate, we are not saying your pension will grow to these levels, we are just using this example to show what someone may give up by opting out of their workplace pension. We are likely to need (or want) more than the state pension will provide for retirement, and the workplace pension can help to provide these additional funds. It is important to understand your pension options to make a fully informed decision before you opt out of the workplace pension. You can learn more about the workplace pension from Gov.uk.
Who is Eligible for the Workplace Pension?
Those who work in the UK will be automatically enrolled by February 2018, if they:
- Are not already in a workplace pension scheme
- Are aged between 22 and State Pension age
- Earn at least £10,000 a year (i.e., £833 a month or £192 a week)
Sources
- UK Household Income Levels from the Office of National Statistics
- Workplace Pension Calculator from the Money Advice Service