The hidden fees that will destroy your pension
Watch out for this Government 'solution' to the pensions crisis... it will wreck all your retirement dreams!
It’s literally been years since the government concluded that automatically enrolling employees into a low cost work-based pension scheme is the answer to the UK’s pensions crisis.
The current opt-in Stakeholder pension system has proved a spectacular failure, quite frankly, with many schemes overlooked by workers. In fact, huge numbers have been left as nothing more than empty shells.
In its place a brand new scheme is emerging under the guise of the National Employment Savings Trust or NEST. Before we look at whether NEST stands a better chance of success, here's a brief rundown of how it will work:
NEST in a nutshell
NEST - formerly known as Personal Accounts - will be introduced in phases starting from 2012, and will eventually oblige all employers to offer the scheme to employees by 2017. Where a work-based pension is already in place - or a new one is introduced - it must be at least as good as NEST.
The key difference between NEST and the Stakeholder pension initiative is that employees will be automatically enrolled in the scheme, although there will be an option to actively opt out if you don’t wish to participate.
NEST is primarily aimed at low to moderate earners who aren’t already part of a pension scheme, and the government estimates millions will benefit as a result.
Of course, auto-enrolment doesn’t really work without automatic contributions. Any employee in a NEST scheme will initially have to pay a minimum of 1%. Employers will match it, with the government contributing another 1% through tax relief, bringing the total to 3%.
These low level contributions will rise over time, so that eventually the total will equal 8%. This will include a contribution of 3% from employers and 4% from employees with a further 1% in tax relief. Both will have the option to contribute more if they wish.
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Any new pension initiative has always caused masses of controversy. NEST is no different, but that’s not really surprising, given the government’s dismal track record on solving the pensions crisis.
But will NEST actually work - and solve the pensions crisis?
Sadly, this month, new facts have emerged which have caused me to have serious doubts about its potential success...
NEST charging structure
For starters, the government has just announced their plan for NEST’s charging structure. The scheme will charge an annual fee of 0.3% based on the value of your pension fund. This is pretty competitive compared with the most keenly priced pensions such as those plans which invest in the low cost index tracker funds.
That said, while the annual charge is perfectly reasonable, NEST falls down on the additional charge on contributions. This will be set at 2% and is designed to meet the costs of establishing the scheme. The charge should only apply in short term, and will disappear once the setting up costs have been recouped. But at this stage it's not clear how long that might take.
Who will lose out?
In fairness, pension experts - including financial adviser firm, Hargreaves Lansdown - estimate the annual charges will amount to just over 0.5% a year for plans which run for the average term. But that means those with NEST pensions that are in place for a shorter period before reaching retirement will lose out.
It’s also bad luck for those who join NEST from the outset in 2012 because these members will bear the brunt of the upfront costs. Those who opt to join later, once the 2% contribution charge has been taken away, may be much better off.
So the worst affected will be those who are due to retire shortly after 2012 and who participate in the scheme from day one. They will see the higher initial charges eat into the growth of their pension savings, and that can’t be a good thing.
- Watch our Why you should save for a pension video
Ed Bowsher reckons you shouldn’t just rely on the state for your pension.
Contribution levels
The charges - while being my biggest concern - are not the only issue to worry about. Contribution levels are also problematic. Members of NEST will be required to pay a 3% employee contribution. But is that really affordable for low income earners? It may sound reasonable, but could compulsory contributions actually encourage some to opt out?
On the other hand, there’s a big question mark over whether a total contribution of 8% is actually sufficient to provide a decent level of income in retirement. This will largely depend on how long members are part of the scheme. Members who join relatively late in their working lives may find this simply won’t be enough.
On top of all that, NEST could actually give employers who were offering more generous pensions before 2012, a golden opportunity to reduce their contributions to the minimum level allowed, leaving employees in a worse position than before.
Recent question on this topic
- maymac55 asks:
retire in 10yrs in noncontributory scheme If I start paying in employer matches my contribution and pays normal payment should i start paying in
- MikeGG1 answered "If you don't contribute you are foregoing free money. So far as the matching money is concerned,..."
- sjrobin answered "After joining you should then look at the investment options. Just simply accept the default fund..."
- Read more answers
A word on means-tested benefits
Finally, there’s plenty of criticism about the potential impact of low level pension savings on means-tested benefits at retirement incuding the benefits that NEST will provide. But I think that's a little unfair. After all, this argument could easily apply to any pension savings for low income individuals, and isn’t an issue which is unique to NEST. In my opinion, those who decide not to save for retirement to preserve means-tested benefits are taking a huge risk. After all, there’s no guarantee how long today’s benefits will remain in place.
If you're in a muddle over planning for your retirement, don't forget to pose a question on our excellent Q&A forum and get help from the lovemoney.com community.
More: Another pensions scandal waiting to happen | Boost your pension by 27%
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How on earth can anyone expect a solution from a Government who thought they were soaking the rich when removing tax credits from pension dividend income? This stunt alone brought in by Zanu NL shortly after they came to power in 1997 has put literally millions of ordinary working people into pensioner poverty. It doesn't matter whether they were defined benefit, defined contribution, AVCs or whatever, the effect has been the same. The dismemberment of the finest pension system in the world. What the youngsters of today have to consider is what will come along and wreck my plans just like they did my grandad. In the 1960s, with profits and endowments were safe and prudent investments. After Big Bang and even Bigger Bonus Bucks they are now dead in the water. Pensions taken out in the 1960s with Guaranteed rates. Now either dead and buried or with funds so emaciated, the guarantee isn't worth the paper it's written on. Of course the youngsters should save - the demographics time bomb is on its' way! Now 4 people of working age support one pensioner. In 50 years time that figure is down to 2:1. Pension credit at a rate miles higher than maximum contributions to basic SRP will be a dream of yore. So will paying your rent and council tax. The future for pensioners over the next few decades does not bear thinking about. 8% Nest contributions are a farce. 20% might do something for you, but for most of the lower paid, an impossible figure to put by and in any case, all taxpayers will be drowning in a sea of benefit debt. I wish I could see a positive. At the moment, with regret, I can't.
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Jane. How about a serious proposal from you instead of deriding the efforts of the Government. How would you solve the pensions crisis?
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Firstly, I must apolgise but I have only read the first two sections of this article - the introduction and "NEST in a nutshell". I refuse to read any further as it is clrearly a totally unresearched article written, one can only assume, by an amateur. Please note: 1 "all employers to offer the scheme to employees by 2017" No, that's the end of the Second Trasitional Period. The First Transitional Period ends on 30 September 2016. The Second Transitional Period merely demands an increase in contributions from both employer and employee to defined contribution schemes such as NEST. 2 "have to pay a minimum of 1%. Employers will match it, with the government contributing another 1% through tax relief, bringing the total to 3%." No, tax relief is at 20% so if the employee pays 1% then the tax relief cannot also be 1%. If the employer only pays 1% (it can pay more), the employee will pay 2% with the tax relief (given through PAYE) being 0.4%. 3 "the total will equal 8%. This will include a contribution of 3% from employees and 5% from employers including tax relief." No, when NEST reaches "Steady State" from 1 October 2017, it is the employer that has to pay 3% and the employee will pay a 5% contribution (although it will only cost him 4% because of the 1% tax relief given through PAYE). As mentioned above, I have not read the whole of this article but, nonetheless, the author should be ashamed for writing such nonsense. I suggest that all readers treat this article, and probably all other articles written by this person, with great caution. I recommend the author refers to the Pensions Act 2008!!
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31 March 2010