Why auto-enrolment and pension freedoms are at odds

It was 2012 when the government pushed through a scheme that aimed to get more people to put money away into their pension pots.

Six years on and the face of auto-enrolment has fattened up.

What started out as a scheme for big businesses has rolled out to encompass almost one million companies of all sizes, with nearly 9.3m British people now saving into workplace pension schemes. And while the minimum rate contributed by both employees and employers was set at two per cent since 2012, the pace has now picked up, reaching five per cent just last week.

Read more: Crunch time for the UK's pension reforms as auto-enrolment hike looms

Of this total contribution, employers now pay two per cent of qualifying earnings, double what they were paying previously. Meanwhile, workers now pay three per cent, up from the minimum one per cent.

Tripling the employee contribution rate has, unsurprisingly, got both pundits and policymakers worried about opt-out rates.

Laura Myers, partner at LCP, says the rise in contributions will force people to make hard choices about what they do with their money.

While the Department for Work and Pensions monitors the number of people opting out of auto-enrolment, it will take months to see the impact of the increase in contributions.

Auto-enrolment essentially relies on inertia, with the success of the scheme largely based on the idea that most people just wont bother opting out.

Its a regime that seems at odds with the 2015 pension freedoms, which revolve around people being trusted to make sound choices for themselves (although lets not forget the overinflated fears that pensioners would blow their entire pot of savings on luxury items like Lamborghinis).

Read more: Pensions: Lump sums dont mean Lamborghinis

If you want to make your own decision about auto-enrolment, theres a few things you should consider before opting out.

The best part of the recent changes is that employers now have to make a minimum contribution of two per cent.

Steve Webb, former pensions minister and director of policy at Royal London, warns that opting out means you would lose your employers contribution – which is money that you wont get in a personal pension.

“Thats a bit like turning down a pay rise,” Webb adds.

In fact, for a decent retirement, the policy director says most people should be contributing far more than the current five per cent.

“The good news is that when a worker pays more, an employer will often match this extra contribution, which effectively doubles your investment.”

But its not all or nothing.

Myers points out that individuals can retain their level of pension savings by “opting down”, rather than opting out – a fact which has garnered little attention.

“Clearly, saving more is always better, but it is essential that – for the financially squeezed – more options are on the table rather than less,” she says. “Without them, they are far more likely to get out of the retirement savings game altogether, and the long-term implications of that are potentially disastrous.”

Next year, the total contribution level will hit eight per cent of earnings. This might sound like a huge jump, but it doesnt even come close to the recommended 12 to 16 per cent people should be saving for decent income in retirement.

“Its imperative that no one is lured into a false sense of security that, just because they are auto-enrolled at a base level, they will have enough to live on in retirement – people actually need to save far more than that,” warns Myers, saying the next challenge is to drive this forward while maintaining current high participation rates.

Read more: Millions of gig economy Britons bypassed from workplace pensions

When you bear in mind that wage rises have been dire for the best part of a decade, the increase to pension contributions will be even harder to stomach for some.

According to figures from the Office for Budget Responsibility, wage inflation is estimated to sit around 2.33 per cent this year. Using this figure, Old Mutual Wealth calculates that someone earning £30,000 a year could expect a take-home pay increase of only 0.76 per cent once auto-enrolment increases are taken into account.

Meanwhile, an individual with an annual salary of £45,000 would get a pay increase of just 0.5 per cent once the higher contribution is taken into account.

“Given the relatively modest average increases in take-home pay this year, many people may not be in a position to divert money to a pension,” says the companys head of retirement policy, Jon Greer.

But as well as the top-up from your employer, he warns that opting out means that youll lose tax relief too, stressing that the decision shouldnt be taken lightly.

This is a timebomb for a state that will simply be unable to support a flood of people hitting retirement without a penny in their pocket

Even if you have your own personal pension set up already, investing through a workplace scheme is a way of diversifying your investments.

Make sure you check the funds your employers pension is invested in, and consider if the performance of the funds are meeting your needs and expectations – sometimes the default is not the best option.

“The onus is on employers, advisers, and policymakers alike to ensure that we continue to gain ground in helping people understand the benefits and importance of pension savings,” says Myers.

“It is also critical that these steps forward are not inadvertently undone for those who feel the contributions uplift is just a step too far.”

For the government, and indeed for all of us, pensions have really become a question of freedom versus security – evident when you look at the two major pension policies introduced within years of each other.

While everyone should be allowed to make their own decisions about their money, there are too many people who are stumped by apathy when it comes to funding their futures. This is ultimately a timebomb for a state that will simply be unable to support a flood of people hitting retirement without a penny in their pockets.

So taking advantage of auto-enrolment makes economic sense from a personal perspective, and from a national perspective too. Essentially this is about exercising your freedom, and having security in the process.

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