Auto-enrolment is coming – why would you want to opt out?

With a few exceptions, the Government's new scheme to encourage retirement saving should be a good deal. Chiara Cavaglieri reports

Chiara Cavaglieri
Sunday 30 September 2012 00:36 BST

Pension saving is at an all-time low with fewer than three million people currently paying into a workplace pension, the lowest number since records began in 1953.

The Government's solution is to put workers into a pension scheme by default, requiring them to actively opt out if they decide they don't want to save. This could be the ideal antidote to our national apathy towards pensions, but tomorrow the largest UK employers are due to launch auto-enrolment, and with many employees still confused, there are some serious concerns.

First of all, an astounding 90 per cent of people in the UK don't know how auto-enrolment pension contributions will be invested, according to a new survey by the pension provider Friends Life. Worryingly, 60 per cent admitted they did not know what auto-enrolment was, with a further 27 per cent saying they are unsure whether they will be auto-enrolled by their employer.

Auto-enrolment has staggered start dates depending on the size of your company, with large employers (at least 120,000 staff) kicking things off this week, although they can delay this by three months. The smallest firms have until 2018 to enrol their staff so there is time to ensure you know exactly how auto-enrolment works and whether it is the right option for you.

Generally speaking, auto-enrolment is a no-brainer – opting out is essentially refusing free money from both your employer and the Government. Initially, under auto-enrolment rules, minimum contributions are set at just 2 per cent, with 0.8 per cent coming from employees, 1 per cent from employers and 0.2 per cent in tax relief from the government.

Pension contributions are paid gross of tax so for a basic-rate taxpayer, each £1 contributed will cost you 80p from your pay packet, before being topped up to £2 by your employer. By 2018, workers must contribute at least 4 per cent and employers will add a further 3 per cent, bringing the total to 8 per cent, when tax relief is included.

"For people on low and middle incomes, if an employer is offering contributions you should be grabbing it with both hands," says Simon Webster at the independent financial adviser Facts & Figures. "If you've got to save in any event and an employer is putting in a significant amount, you would be insane not to take it."

Employer contributions and tax relief are certainly huge incentives, but it is important to keep in mind that pensions are just one way to save for retirement – and a fairly inflexible one at that. For many workers, particularly those who have large debts and have perhaps seen retirees disappointed by stock market falls and low annuity rates, pensions are a difficult sell.

Dr Ros Altmann at Saga argues that auto-enrolment should be about encouraging saving, not just selling pension products.

"If people are not keen on pensions, that does not mean they should not save. There are other valid forms of saving that we need to encourage – such as repaying student debt, or saving to buy a house," she says. "Policy seems to believe that, when it comes to encouraging workplace savings, it has to be pensions or nothing. That will leave many with nothing."

Older people on low incomes may be wary of auto-enrolment. The current means-tested pension credit system is so complex that it can be tricky to calculate whether workers are always better off saving. If people are to be pushed into saving for their retirement with a workplace pension, they need to be absolutely sure that they will be better off by doing so. People with small pension pots may want to opt out too if they lose the right to take them as a lump sum under so-called "trivial commutation" rules.

Danny Cox at Hargreaves Lansdown explains: "Those over 60 with pension pots of £18,000 [the current limit for this tax year] or less can use the triviality rules to take the whole of their pension fund as cash, 25 per cent tax free, 75 per cent taxable. If auto-enrolment pushed their savings above £18,000 they would not be able to do this."

Anyone who has already accrued an enviable pension pot will also have to tread carefully, as those with pension savings above the lifetime allowance (currently £1.5m) face a 55 per cent pension excess charge when the benefits are realised. This applies only to the excess above £1.5m, not the whole pension, and the combination of employer contributions and tax relief at the higher tax rate should mean that enrolment is still worthwhile.

The exception here, however, is if you took out fixed or enhanced protection in the past. When the lifetime allowance was introduced in April 2006, those affected were able to opt for enhanced protection against any future lifetime allowance charge, on the proviso that no further contributions were made. Similarly, when the lifetime allowance was reduced from £1.8m to £1.5m last year, people were able to apply for fixed protection which meant they could freeze the higher allowance at £1.8m, again on the condition that not a single penny more is put into any pension funds.

So if someone failed to opt out of auto-enrolment and lost their fixed protection it could result in a hefty tax bill of up to £165,000 (55 per cent of the difference between £1.8m and £1.5m).

And if you do decide you want to opt out be prepared for an ongoing battle. Initially, you have one month after being automatically enrolled to leave the scheme, but employers are required to reapply the auto-enrolment every three years – which means that if you are determined not to have a workplace pension you will have to actively opt out once every three years.

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