Did you know that if you have a workplace pension, that you are already an investor?
The state pension was introduced in the UK in 1908. It was means tested and the retirement age was 70. The problem here is that the average life expectancy in the UK in 1908 was 52! This meant that the government didn’t have to pay out much.
Today the retirement age is 68 and the average life expectancy is 82 so the government now must pay out quite a lot! State pensions are paid using people’s National Insurance contributions.
It should be that they take these contributions, invest them throughout the years then pay them out to you when you retire, however, this is not the case. Because they didn’t expect to pay out much in the beginning, they didn’t invest the contributions and now they just take the contributions that today’s workers are paying and then paying those contributions straight out to current pensioners. As the average age of the population increases, this is becoming a bigger burden on the government. This is why they keep increasing the pension age.
Today’s state pension is only worth £11k a year and few can survive on that. To bridge this gap, we have workplace pensions. If you have a workplace pension, you are already an investor. It is never a wise idea to opt out of a workplace pension as you are throwing away the free money from your employers contributions. Very few places hand out free money these days so take what you can while you can for as long as you can.
There are 2 different types of pensions: Defined Benefit and Defined Contributions.
There are not many places that offer Defined Benefit pensions anymore except for government related jobs such as the NHS, teachers, police etc. You make contributions, your employer makes contributions and then at the end when you retire, they will promise you a certain amount per year such as £20,000 per year. You don’t have much control over these pensions in terms of optimising them, you just have to accept what is offered. You can however open your own private pension (SIPP) and will have control over that.
The other type of pension is a Defined Contributions pension. As this is the most common type and you have more control over how you can optimise the end outcome, I will mostly be concentrating on this type of pension in this email.
If you are between 22 and state pension age (the government has plans to change this to 18 at some point), and earn over £10,000 a year in one job, you will be auto enrolled into a Defined Contribution workplace pension of your employers choice (your employer has the option to defer the auto enrolment by 3 months at the start of employment until you pass probation to make sure you are staying with the company). If you are under 22, you can still opt into the pension, just ask your employer to opt you in.
Workers who earn less that £10,000, but more than £6,240 can opt into the workplace pension and receive employer contributions. If you don’t meet these criteria but still want to join, you can do but your employer is not obligated to contribute.
The minimum contributions are set by the government and are currently 8%, of which 3% must come from the employer and 5% from the employee. The contributions are made either before tax is calculated on your payroll, or collected by the pension provider directly from HMRC, depending on how they work, so you pay no tax on the way in, only when you withdraw from it in retirement. There is a common misconception that you pay tax when you contribute and again when you withdraw at retirement leading people to complain that they’re taxed twice. This is not true. You’re only taxed once and that’s when you withdraw.
You can also use salary sacrifice if you would like to pay more. This is calculated before tax and NI meaning a tax and NI saving for the employee and an NI saving for the employer. You cannot sacrifice your salary below minimum wage.
If you have changed jobs over the years, you may have several workplace contributions. There is a free government pension tracing service but be careful, they can try and send you to costly pensions advisors like St James Place. They are very expensive, currently under investigation for their fees and not necessary, I would avoid them like the plague.
I traced 3 former workplace pensions simply by contacting all my former employers, asking them what workplace pension provider they use and then contacting the providers to find my pensions. Employers weren’t obligated to provide its employees with a workplace pension until 2012-2015 starting with the biggest companies and filtering down to the smaller companies, so you may not necessarily have had one with every former employer. I’ve had a whole bunch of jobs over the years, but I only had 3 workplace pensions.
I personally wouldn’t leave any contributions in old workplace pensions. This is because they’re harder to keep an eye on when there are multiple pensions in different providers and your old employer could change things about the pension that might make it less favourable such as moving it to a poorer performing fund, and you might not realise with not being there anymore.
I set up a Vanguard SIPP and through them I was able to transfer all 3 pensions into my SIPP, so I had more control over them and where I invested them. It was easy and only took a few weeks.
If you have a workplace pension with your current provider, it is important to check who it is invested in and where. According to NEST, the UK’s leading workplace pension provider, 99% of people just leave it in the default fund that NEST choose for you. People do this because they don’t know what a good fund looks like and this can cost you very dearly over the life-span of a pension.
So what do you look for when choosing a fund for your workplace pension? I will talk about them in order of importance. Mostly I look at fees but there some other factors to look at too. First, ask the pension provider to provide you with a fund factsheet and ask them what all the fees are. This can be hard to find as a lot of pension providers seem to us a smoke and mirrors approach to obscure or embellish the facts with misleading or irrelevant information. The key is to be persistent in getting the information you require out of them. Your retirement depends on it.
Every pension company will have platform fees and fund (OCF – ongoing charge) fees, you can’t really get away from these but you can look for ones that are as low as possible. I would look for something less than 0.5% for these 2 fees combined. Unfortunately, some pension companies add more fees on, such as a fee whenever you make a contribution (deal fee), advice fees and exit fees should you decide to leave them. These extra fees will eat a massive hole into pension and should be avoided as much as possible. If your employer is nice enough, they may pay your contributions into your SIPP instead of a workplace pension but they’re not obligated to agree and make sure your SIPP provider allows this first. Vanguard, for example, doesn’t.
So, you’ve found the fees and they don’t look too bad. What else would I look out for? I would look to see if the fund is active or passive. Ultimately, I would only choose a passive fund, which is one that is not actively managed by someone, it’s just left to track the market. Actively managed funds are usually high in fees and poorer performing.
I would then check what the equities and bond ratios are. I’m not a fan of bonds so I would choose a fund that is 100% equities as they perform better over the long term. Bonds help to preserve your wealth in retirement, equities focus on growing your wealth in the long term while you are still working.
Next up I look at how diversified the fund is. So I would see how big the fund size is, the bigger, the better. Small sized funds won’t have the funds to properly track the market. You want to aim to own as much of the market as possible. It needs to have thousands of funds in many countries and as many different industries as possible. It’s the exact opposite of stock picking. If I just invested in Google and they went bankrupt, I’d lose all my money. That’s gambling. If you spread your money out over 1000’s of companies and a few go bust, it barely makes a difference to your portfolio. The important thing to remember is that the stock market as a whole has, historically, gone up on average by 10% per year. Sure, there are some bad years like during 2020 and 2008 but the market has always recovered and gone up again. My SIPP fund has over 7000 companies across the world in it, totalling £1.9 billion, for reference.
So, to sum up, if you have a passive workplace pension fund with low fees that is very diversified, both in terms of size, countries and industries, and is 100% equities, you likely have a decent pension.
Don’t worry if you don’t understand all the terminology that I’ve just thrown at you (sorry about that). It’s really hard to condense this information down into an article. I’ve been asked a few times recently about investing and why I don’t talk about it more in my social media and this is exactly why. It would be irresponsible of me to chuck a tonne of information at you without explaining it fully and making sure that you’re in a good position to start investing. For that reason, I’m thinking of doing some Youtube videos to fully go through it. I’m not a financial planner and I’m not allowed to give financial advice, but what I can do is explain what I do and what options are available out there so stay tuned, it’s in the works 🙂
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*Quick disclaimer – I am not a financial advisor, I do not give financial advice and you are responsible for your own financial wellbeing 🙂
Lauren <3