Is the auto enrollment scheme beneficial for those paying income tax at the higher rate

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?

Average Industrial Wage

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.

Higher Earner

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.

Flexibility

The auto enrollment scheme is a one size fits all scheme and as such, there is no flexibility.

1. No AVC facility. An employee cannot pay extra into the scheme if they want. This is especially important for higher earners who may wish to boost their retirement pot through additional contributions.
2. Cap on employer contributions. You cannot negotiate a higher employer contribution to your pension from your employer, 6% is the fixed amount. And that is after 10 years. It is 1.5% for the first 3 years. You can expect any future increases to take years of negotiations with employer bodies before it is put in place. If your salary goes over €80,000, your employer does not have to make contributions above this amount, so the employer contribution is capped at €400 per month.
3. The retirement age is tied to the payment of the State contributory pension, which is currently 67. There is no option to retire before then expect for ill health early retirement. With your own private pension you can draw down your pension benefits from age 50. So you can retire when you want and not when the government lets you.

Steven Barrett

11 April 2022