One of the features of the auto enrollment pension scheme is that members will not get tax relief on their contributions. Instead, the State will make a top-up contribution to your pension pot and your own contributions will be deducted from your net salary (the payment amount will be calculated from gross salary). The government believe this is easier to understand and everyone gets the same level of State contribution of 1/3 of the employee contribution. This is a change from the traditional tax relief at your marginal rate, which will be 20% or 40% depending on your income.
If you are paying income tax at 40%, you are obviously losing out. But the auto enrollment scheme will have a fees cap of 0.5% which will be lower than most private pensions. Ss it better to be in the auto enrollment scheme and paying lower fees or to set up your own private pension?
We will look at a 30 year old single person who is on the average industrial wage of €44,955. In this illustration I am going to assume the full payment of 6% of gross salary from employer and employee with 2% contribution from the State. This works out at €224.78 from the employer and a combined amount of €299.70 between employee and State. The total monthly contribution is €524.48. Their salary increases by 2% each year to age 67. The gross return on their fund is 5% or 4.5% net after charges.
At retirement age 67, they will have a pension pot of €774,860.
If this worker contributed to a company pension and got tax relief the traditional way, how would he get on? The employer contribution does not change at €224.78 but when tax relief at 40% is taken into account on their personal contribution, this increases to €374.63 for the same net cost of €224.78 per month. A total of €599.40 is contributed. However, with higher charges, their fund has net growth of 4% per annum.
At retirement age 67, they will have a pension pot of €800,999, a difference of €26,139.
What if you are a higher earner? We ran the numbers for another 30 year old, this time on a salary of €80,000. What is the impact for those with higher salaries?
Under the auto enrollment scheme, the employer contribution is €400 per month with a combined employee and State contribution of €533.33 a month, giving a total contribution of €933.33 per month.
At retirement age 67, they will have a pension pot of €1,378,890.
If this worker contributed to a company pension, they would contribute €666.67 gross, which when added to their employer contribution would see €1,066.67 contributed each month.
At retirement age 67, they will have a pension pot of €1,425,427, a difference of €46,537.
The actual difference will be higher because there is an earnings cap of €80,000 on employer contributions that we did not apply for this example. Under the company pension, the employer contribution will increase as the employee’s salary increases at 2% per annum. It will remain fixed under the auto enrollment scheme.
The auto enrollment scheme is a one size fits all scheme and as such, there is no flexibility.
11 April 2022