The future of your pension

The government is phasing in a new pensions scheme for employees from next year onwards. How will it affect you?

We’re entering into a new era of company pensions. The government is planning to make it obligatory for us and our employers to contribute to a private sector pension. Here are the details of the plan that could radically change your pension plans.

What is NEST?

The new scheme is known as NEST, which stands for National Employment Savings Trust. It is a new kind of defined-contribution pension scheme that all companies (however large or small) must offer to all their employees. This is unless the employer is already offering workplace pensions that provide at least the minimum amount of contributions required by NEST.

When will the changes take place?

The NEST scheme will begin next year, but the time when employees are moved on to it will depend on the size of the company they work for.

There is going to be a phased introduction of the scheme, with larger employers needing to provide their employees with a suitable pension scheme sooner than smaller ones. So, a company that employs more than 120,000 people will need to achieve this by October 2012, while some companies employing less than 50 people will need to achieve it by January 2016. 

How does it work?

Put simply, this new scheme means that all employees will have some form of company pension, either with NEST or with another workplace pension scheme. Employees and employers will be expected to contribute to these company pensions.

The money from these contributions will then be put into investment funds. You will have some choice which investment funds are used, with some ethical/socially-responsible funds available to use.

When employees retire, they can then use the money that has been saved to buy a pension, which will go on top of their state pension, hopefully giving them a comfortable retirement.

How does it affect me?

This depends on your situation.

NEST will only apply to employees who are over 22 years of age and earn in excess of £5,000 a year.

Employees with final-salary, money-purchase or stakeholder pension schemes. You may not be affected at all by the NEST scheme. If your employer’s contribution to your pension scheme is greater than the minimum level required in NEST (for the next few years, 1% of your current salary), then they will not be obliged to change over to NEST, although they can choose to.

Employees without a company pension. In this case, your employer is obliged to add you to a NEST scheme or to another pension scheme with a similar level of contributions. So, you will get a new company pension by 2016 at the latest, but probably much sooner than that.

Why has NEST been brought in now?

There is currently a huge shortfall in the amount that people are saving for their pensions.

According to the Department for Work and Pensions, seven million people in the UK are not saving enough for the retirement they will want or expect. Two and a half million less people are saving using company pensions than in 1995.

The country’s population is ageing, and if this shortfall is not rectified it could lead to a real crisis in our pension system, and millions of pensioners living through their retirement in poverty.

The government’s solution is to bring in auto-enrolment schemes like NEST, where employees are put into a scheme automatically and can only opt-out. This should result in many more people saving in company pensions.

Can I opt out of NEST?

Yes, but...it’s not a good idea.

If you do not already have a company pension that fits the NEST minimum standards, you will be automatically enrolled in NEST. It is possible to opt out, but if you do then you will not receive any of the contributions that your company will set aside for it. Unless you renegotiate your contract, you would be effectively taking a pay cut.

What will happen to my current work-based pension?

If your current work-based pension does not require your company to contribute the minimum amount required by NEST, then the company will need either to increase their contributions or move over to NEST.

On the other hand, if your company pension does meet the NEST standards, then your employer is not obliged to change it, although they may choose to.

Where employees should be careful is if their employer decides to change their pension scheme. It is possible that a company could decide to change from a generous pension scheme to a NEST scheme where it just pays the minimum level required. Employees would lose out in that case, and should be watchful over any changes to company pension schemes.

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How will the contributions work?

The plan is that both employees and employers will only need to start paying their full contributions for NEST schemes by 2017, but they will need to pay a smaller contribution before then.

Up to 2016, employees and employers will each have to contribute the equivalent of 1% of the employee’s salary, and another 1% will be contributed through tax relief.

This will rise in October 2016, when a total of 5% of the employee’s salary will need to be contributed, with at least 2% coming from the employer. The full contributions will come in 2017, when a total of 8% of the employee’s salary needs to be contributed: 4% from the employee (with added tax relief) and 3% coming from the employer.

There will also be some charges in the scheme, although they are relatively low. These will be a 2% charge on the value of each contribution, as well as an annual management charge of 0.3% of the value of the fund.

Can I contribute more than the minimum?

Yes, up to a certain level.

There is a cap that limits the total amount that can be contributed in a single year. At present, that cap is £3,600 a year, a figure that is based on the level of earnings in 2005, although a recent government review of NEST suggested that the cap should be abolished by 2017.

As long as your contributions do not go over this cap, then you can pay more than the minimum amount required in a NEST scheme.

Is this really just a pay cut?

In the short term, it could be. In the long term, it shouldn’t be.

The reason for this distinction is that in the short term, employers may decide to cut salaries (or start new salaries at a lower level) in order to finance increased pension contributions. This may be a particular issue for people in companies without pre-existing pension schemes.

In the long term, though, it shouldn’t be a pay cut. You will receive the money, only when you are retired and not immediately.

Will employees be better or worse off as a result of these pension changes?

Again, this will depend on your situation and how far ahead you are looking.

Employees will be more likely to have a comfortable retirement as a result of this policy. It forces people to save for a retirement. If this policy was not brought in, there is a serious risk that many people, particularly in small or medium-sized firms without workplace pension schemes, would not have enough to pay for the retirement they want. They may take a relative pay cut in the short term, but in the long term it will be worth it.

For employees already with a company pension, the scheme will have no discernible impact, unless their employer decides to switch over to NEST.

Tell us about what you think of this new scheme

Is it unfair to individuals and businesses, or is it the best way to provide a comfortable retirement to employees?

More: Government cuts will hit your pension I How to double your pension