Most UK employees are now automatically enrolled into a workplace pension when they start a job, but many people have little understanding of how their pension actually works or how to maximise it.
- Auto-enrolment — how it works
- Defined benefit versus defined contribution
- Where is your pension invested?
Auto-enrolment — how it works
Since 2012, employers have been required to automatically enrol eligible workers into a workplace pension scheme. You are eligible if you are aged between 22 and state pension age, earn more than £10,000 per year, and work in the UK.
You can opt out of auto-enrolment if you choose, but doing so means giving up your employer's contributions — which is almost always a costly mistake.
Contribution levels
The minimum total contribution under auto-enrolment is 8% of your qualifying earnings, with at least 3% coming from your employer. Most workers contribute 5% themselves and 3% comes from their employer, though many employers offer to match higher contributions.
Always check whether your employer will increase their contribution if you increase yours. Many employers will match contributions up to 5% or even higher. If your employer matches 5%, contributing 5% yourself immediately doubles your money — it is the best investment return available anywhere.
Defined benefit versus defined contribution
There are two main types of workplace pension. Defined benefit pensions — common in the public sector — promise a specific retirement income based on your salary and years of service. These are extremely valuable and generally much more generous than defined contribution schemes.
Defined contribution pensions — now the standard in the private sector — build up a pot of money based on contributions and investment returns. At retirement you use this pot to fund your retirement, either by buying an annuity or by drawing down the money directly.
Where is your pension invested?
Most workplace defined contribution pensions invest in a default fund, which is typically a multi-asset fund that gradually shifts from higher-risk investments to lower-risk ones as you approach retirement. This is fine for most people, but it is worth understanding your options and considering whether the default suits your circumstances.
Bottom line
Your workplace pension is one of your most valuable financial assets. At minimum, always contribute enough to get your full employer match. Increase contributions when you can, and review your investment choices to make sure they align with your retirement timeline.