Pensions...for those at the early stages of their career, retirement can feel so far away. What's more, it’s expensive, meaning the idea of opting out of your employer pension scheme might be alluring if you'd rather have the cash in hand now.
Let’s look through if it’s possible and if it’s actually worth opting out of your pension.
Employer pension basics
Before leaping in, here’s a bit of background: the UK government saw the need to encourage private pension savings and introduced a policy in 2012 to automatically get workers to save into a pension. This means that all employees over the age of 22 and earning more than £10,000 automatically get added to an employer pension.
The government set in place some minimums, to make sure that both employers and employees were fairly contributing. The minimum amount that must be contributed by you as an employee is 4% of your salary. Your employer must contribute a minimum of 3% of your salary. They, and you, can opt to contribute more, but this isn’t obligatory. The government then tops the contributions up by adding an extra percentage relevant to your tax bracket, which takes the total obligatory contribution to 8% of your salary going into a pension every year.
For example, if you’re a basic rate tax payer, (earning less than £50,000 per year) you’ll be paying 20% income tax. As a result, an extra 20% will be added to your pension contribution. This means that if you’re a basic rate tax payer, you only need to contribute £80 to actually have £100 added to your pension with tax bonuses. The £20 comes from the 20% that the government gives you back and adds to your pension.
As the government is incentivising people to boost their pension pots, they don’t want them dipping into the money saved every time they fancy a new car or handbag. Any contributions that are made to an employer pension can’t be accessed until the age of 55, or 57 by 2028. This is non negotiable, unless you have a terminal illness and proof of such. Moving abroad and transferring doesn’t negate these restrictions, so don’t even think about trying!
It’s worth noting that the automatic employer pension contributions are in addition to your compulsory National Insurance contributions to the state pension. These will be just over 10% of your salary and you start to access the state pension at the age of 67.
Is it possible to opt out of my pension?
It certainly is possible, and any one can choose not to make compulsory employer pension contributions. Whilst you will be automatically added to a pension scheme once you’re earning over a certain amount, you can instruct your employer to cease to make these contributions for you. Hold up though. It doesn’t cancel any contributions you’ve already made and you can’t claim these back as they will still fall under the pension umbrella, which is protected until you reach a certain age.
Opting out of your pension comes with certain advantages and disadvantages that are worth considering before making any hasty decisions. For most of us, our pension is the biggest asset that we will ever hold and needs to fund potentially 20 years or more of life without earning, which is not to be underestimated. Let’s check out what the potential implications might be of opting out.
Retirement savings are essential. Opting out of your pension will leave you at a disadvantage.
Cons of opting out of your pension
- You lose the additional employer contributions: This is a key benefit of sticking with your pension contributions. Anything that you save will be increased by the contributions that your employer makes. Turning it down is like saying no to a pay increase. So if you’re considering opting out of your pension and simply investing in other ways, really you’d need to be saving even more to make up for the contribution losses that your employer would’ve made. Some employers may also be keen to increase contributions to your pension over the minimum if you show equal willingness, boosting your savings even further.
- Loss of tax benefits: As employer pension schemes are often organised by your HR department, the contributions are taken pre tax, without you needing to file self assessment and reclaim, unlike in a personally arranged SIPP (Self Invested Personal Pension). If you decide to opt out of this pension scheme, then you will lose the tax benefits on contributions. Employer pensions, and SIPP’s, also come with the benefit of tax free growth. Most other platforms and methods of saving and investing don’t come associated with such benefits.
- Increased administration: Most of your employer pension arrangements will be done automatically and without much input from you, contributing to your future without much effort. If you decide to opt out of your pension, it really is important that you’re making other arrangements to ensure that you’re able to retire when you want and in the way that you would like. Without your employer pension scheme, it’s likely that you will need to make other provisions that could come associated with a headache or more organisation and management.
- You can’t take advantage of salary sacrifice schemes: If you’re earning over £100,000, there are certain tax mitigation techniques that can be applied with your employer pension scheme, such as salary sacrifice. This is where you forgo salary in exchange for larger pension contributions, to reduce losses to your personal allowance and essentially pay less tax on what you earn. If you opt out of your pension, you would have to find other ways to mitigate tax, which may be more complex, or simply face a higher tax bill.
- The disciplined savings go out of the window: As it is a pension scheme, you can’t currently access any of it before the age of 55. This means you can’t be tempted to dip in and potentially harm your retirement as it simply isn’t allowed.
- Opting back in can be slow and arduous: Employers do have to let you opt back in, should you wish to again in the future. However, depending on when they conduct their pension enrolments, you might have to wait for the next quarter, six months or even a year, missing out on a valuable period of time when you could’ve made pension contributions.
- Reducing potential future quality of life: Did you know that women start their careers with 16% less in their pensions and by the end of their careers they have nearly half the amount that men have in their pension pots. By choosing to leave or not contribute to your pension, the potential sacrifice on future wealth is not to be taken lightly. Given that women have extra leg work to put in to make up for the shortfall with mens pensions, the more that we can get from employers and government tax benefits, the better.
Pros of opting out of your pension
- Pension restrictions apply meaning you lose flexibility: As we’ve just said, you can’t access this money, for love nor well money (pardon the pun) before the age of 55. This means that your money is locked away and can’t be used for other purposes, like early retirement or property purchases. By opting out, you can be more flexible with your savings.
- Extra disposable income will be available: As your pension contributions will come from your salary, you are unable to use that cash for spending in the present moment. If you’re feeling like you need extra cash, opting out of your pension will give you another 5% of disposable income.
- You might be able to find a greater investment selection elsewhere: As employer pension schemes are often managed on a national level, the investment choice is often limited. Usually it’s based on a selected risk profile with few flexibilities to select specific stocks, funds or ETF’s. This can mean that you invest into companies that don’t align with your ethics and can also compromise your growth potential, as there are certain restrictions in place designed to protect pension savers.
- It can be a temporary decision: Just because you’ve decided to opt out now, doesn’t mean that you can’t opt back into your pension again in the future, perhaps when circumstances have changed. In the future, you might even be able to increase your contributions to make up for the shortfall in the time period that you’ve missed out on making contributions.
The bottom line
Whilst there are some cons to the restrictive employer pensions, the compulsory contributions and tax benefits make it a bit of a win-win situation.
To try and maximise any potential growth on your pension, make sure that you involve yourself as much as possible with any choices on investment selection that are given. As a rule of thumb, the longer time period that you have, the more risk you can afford to take with investments. If you’re at the beginning of your career therefore, retirement is potentially a long way away, meaning that you might be able to review and push boundaries more than you had thought, which may open you up to a greater growth potential as well.
Last but not least, it’s not just about the current contributions but also the ones that you’ve already made. Keep track of pensions from previous jobs by ensuring your paperwork and contact details are up to date, as everything counts towards building your retirement pot.