Millions of people will eventually be automatically enrolled into a workplace pension involving a monthly contribution from their wages, their employer and the government to ensure that low and middle earners do not have to rely solely on the state pension.
For most workers enrolling in the scheme this will be the first time their employer has contributed to their pension savings, if indeed they have made any savings at all.
Pensions Minister Steve Webb said on Saturday’s BBC Money Box, "We have got half the workforce building up no pension beyond the state pension, and that is why this system is such a positive thing. You don't have all the hassle and complexity of choosing a pension. The firm chooses it for you, they put money in, you put money in, and then the only hassle is if you want to opt out".
The scheme will automatically include workers aged between 22 and retirement age if they are not already in a company scheme and earning at least £8,105 a year [i.e. the current income tax threshold].
The contribution they, and their employers, make will be based on their wages. The first £5,564 a year will not be taken into account and any earnings above £42,475 will also be exempt in the contribution calculation. In the first instance the contribution from the employee will be a minimum of 0.8% of their earnings between the limits above.
Their employer will be obliged to add the equivalent of 1% of their earnings and tax relief will add another 0.2% making a total of just 2%. But eventually, these minimum contributions will rise to a total of 8% being 4% from the employee, 3% from their employer and 1% in tax relief.
These funds will be invested in either a company's existing workplace pension scheme or a government-backed scheme, the National Employment Savings Trust (NEST).
Only the largest employers with hundreds of staff will be involved in the first wave of automatic enrolment. Other smaller firms will then join as the system is rolled out up to 2017 with micro firms joining in the very last stages.
If an employee aged 22 on a salary of £20,000 p.a. saved for 40 years at the full 8% they would benefit from total contributions of just under £52,000. If the pot was invested over the 40 years and enjoyed an average 4% p.a. return a pot of £112,107 would be accrued. Annuity rates are very variable and very low at the moment but this sum might provide an inflation linked pension of about £287/month. This would supplement the state pension of £465/month
Workers will have the option to opt out of the pension savings scheme but they must make a formal, written request to the pension provider, not the employer.
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