You are turning down free money!

Say no to your employer's pension scheme and you'll have made one of the biggest ever financial mistakes.

Do you find pensions a bit of mystery? If you do, you’ll probably join one third of people in the UK who have a work-based pension but have absolutely no idea how much their employer is contributing into it on their behalf.

The Department of Work and Pensions' (DWP) new Attitudes to Pensions Survey reveals that in addition to these clueless pension savers, almost six in ten (59%) people who work in the private sector have rejected their work pension scheme entirely. This statistic is even more worrying since that means many employees are effectively passing up free money from their employer. Worse still, they’re wrecking their chances of building a decent nest egg by the time they reach retirement.

You’ve just taken a pay cut  

If you have passed up the opportunity to join your employer’s pension scheme, I really believe you should rethink your decision.

Think about this way: The pension contributions employers make for their staff will be factored in when setting remuneration so that the pension becomes a part of the overall salary package. If you don’t join the pension scheme, your total remuneration will be less than somebody who gets the same basic salary as you but has signed up. So, by refusing to take part in the scheme, not only will you have missed out on your employer’s contribution, but you’ll also have effectively taken a pay cut.

How much difference could it make?

Even a seemingly low level of contributions can help you build a much healthier pension pot at retirement. Imagine your employer offers a pension scheme into which they are willing to pay, say 5% of your gross salary each year. If you earn £24,000 this would equate to a total payment for the year of £1,200 or £100 per month.

If you’re 35 now and you intend to retire at 66, the monthly contributions of £100 could potentially grow into a pension fund worth £62,880* by the time you stop working. So, you can see if you turn down the option to join your employer’s pension scheme, you could literally be missing out on thousands and thousands of pounds which should be going into your pension fund. 

Of course, if you make personal payments into the pension scheme in addition to your employer contributions, the accumulated pension pot will be even more valuable by your 66th birthday.

And, don’t forget, you’ll also qualify for tax relief on your contributions which provides an even bigger incentive for saving in a pension. Tax relief effectively rebates the tax you have already paid on your pension contributions which have come out of your taxable salary.

If you’re a basic rate taxpayer, for example, you’ll qualify for tax relief at a rate of 20%. This means you’ll only need to pay £80 out of your own pocket for £100 to be invested in your pension scheme.

Meanwhile, higher rate tax payers are entitled to 40% tax relief and additional rate taxpayers qualify for 50% tax relief on their own contributions. The extra tax relief can be claimed via a self assessment tax return. That said, tax relief has been restricted for people who make large payments into their pension above £50,000 a year. You can read more about the new rules in Government cuts will hit your pension.

* This figure assumes the pension grows at an annual rate of 7% with charges of 1%. Annual inflation is taken into account at a rate of 2.5% so that the figure is shown in today’s money. The monthly employer contribution also increases by 2.5% per annum to keep pace with inflation.

The devastating effects of delay

Perhaps you have every intention of taking part in your work’s pension scheme, but just not right now. It’s pretty common for schemes to require contributions from you which your employer will then match. Maybe you have delayed joining until the pension becomes more affordable.

Whatever the reason for putting your pension off, it can have devastating consequences on the final value, even if you only delay for a relatively short period. If you join your employer’s pension scheme at 40, instead of 35 as in the example above, your pension fund might be worth just £48,102 by the time you retire at 66. That’s means a delay of only five years has knocked a massive £14,778 off the value of your pension pot.

Moving jobs

In fairness, the current system does little to encourage employees to become pension savvy. When you change jobs, for example, you’ll find many prospective employers aren’t in the habit of telling you about their pension scheme until you have already accepted the position. At this point you could even find there is no scheme available, which means you’ll be solely responsible for your own pension provision with no employer contributions to fall back on.

In fact, research from the National Association of Pension Funds (NAPF) shows that just four out of ten (40%) people were aware of the pension scheme on offer when they applied for their current job. And less than one in eight (12%) of job adverts provide any pension information. 

Always remember a work-based pension can represent a large part of your overall remuneration. Some of the more generous schemes can provide contributions worth up to 35% of salary. You should view your employer's pension as an absolute necessity rather than a ‘nice to have’ benefit. So do make sure you ask about it next time you have a job interview if the information isn’t forthcoming.

Things should get better

Having said all that, the pensions framework should improve in the future with the launch of the National Employment Savings Trust or NEST, which will be rolled out from 2012. NEST obliges all employers to offer a pension scheme to their employees which meet a minimum set of requirements, including a minimum contribution which must be partly paid by members of staff themselves and partly met by their employers on their behalf.

What’s more, unlike the current system, employees will be automatically enrolled into the NEST scheme if a work pension which meets the criteria isn’t already in place. Workers will have to proactively opt out if they don’t wish to take part. You can find out more about NEST in Q&A - National Employment Savings Trust (NEST).

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