Better investment and salary exchange can tackle cost of minimum contributions

Better investment and salary exchange can tackle cost of minimum contributions

The significant cost increases that will come from the rise in minimum contributions set to take place tomorrow can be mitigated through shifting pension schemes to improved investment arrangements and setting up salary exchange arrangements with employees.

The next stage of automatic enrolment onto workplace pensions will take place tomorrow, with minimum contributions set to rise from 2% to 5%. The 3% rise in minimum contributions will see employers contribute 2% of qualifying earnings, while employees will stump up the other 3%.

Commenting on the rise in minimum contributions, Maria Nazarova-Doyle, head of defined contribution investment consulting at JLT Employee Benefits, doubted whether enforcing greater pension contributions will be the panacea the government hopes it will.

She explained: “Whilst greater retirement savings are to be universally encouraged, the benefits of the increase will be eroded significantly if it is not accompanied by a review of the default investment strategy of a defined contribution pension scheme.”

Losses incurred from participation in a poor-quality default fund negates much of the progress made by increasing contributions for a saver starting from scratch, Nazarova-Doyle argued.

“The projected value of savings for a 22-year-old starting to save into a pension with 5% contributions using a poor-quality default fund is almost identical at age 55 if that person continued on the current 2% contributions and chose the best available default fund.

Nazarova-Doyle said: “If scheme trustees and sponsors could take care to choose an appropriate, best performing investment arrangement, the outcomes for savers could be exactly the same without having to reduce their take home pay. The importance of choosing a good quality default strategy cannot be overestimated.”

“When auto escalation is implemented for schemes with strong investment governance arrangements, the combined effect of increased contributions and increased investment returns can create truly impressive results.”

Paul Falvey, tax partner at accountancy and business advisory firm BDO, pointed to salary exchange arrangements as a means of managing the costs from the rise in minimum contributions.

He said: “Auto enrolment was introduced partly to make it easier for employees to join a workplace pension scheme and partly to make pensions more financially attractive by making it compulsory for employers to pay into eligible workers’ pension schemes. However, there are inevitable costs for both employees and employers. Putting a salary exchange arrangement in place will help to reduce these costs.”

“Through these arrangements employees agree to give up some salary or bonus to protect their net take-home pay. The amount given up is used by the employer to provide an alternative benefit, in this case an increased employer pension contribution. As the employee is being paid less gross salary, the employee makes national insurance contribution (NIC) savings (up to 12%). Employers will also save NIC, making it a win-win all round.”

Andy Tarrant, head of policy at The People’s Pension, the second largest master trust in the UK,  added that “employers and the government have a responsibility to ensure that savers understand the long-term benefit that these increases will bring”.

He said: “While putting a little extra into a pension pot may feel like a financial squeeze for some people, it’s hugely important to remember the significant increase to their savings that will come from their employer. This change means employers are required to put in double the amount of free money towards their employee’s pension pots than they currently have to.”

“Over time, this, combined with the top-up they’ll get from the government, will all rack up and make a huge difference to people’s futures.”

Categories: News, UK Pensions

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