How much do I pay into the pension fund?
How much is the employer paying as well?
What are my choices, what does up to 5% mean?
It's up to you what you pay into your company pension.
If you choose to contribute nothing – from what you've stated above, it sounds like the company also contributes nothing. (But see note)*
If you choose to contribute to the company pension scheme, they will double anything you contribute, with a limit to their contribution of 5% of your gross salary. As follows:
Figures = monthly, based on gross salary of £2,083/mth.
you pay in | they pay in | Total added to
(%) (£) | (%) (£) your pension fund
0% £0 0% £0 £0
1% £20.83 1% £20.83 £41.66
2% £41.67 2% £41.67 £83.34
3% £62.50 3% £62.50 £125.00
4% £83.33 4% £83.33 £166.63
5% £104.17 5% £104.17 £208.34
6% £125.00 5% £104.17 £229.17
10% £208.33 5% £104.17 £312.50
Important note: Tax relief
These contributions are taken from your salary before Income Tax and National Insurance. This makes them very tax-efficient. In other words, whatever you have put into your pension you have not been taxed on. So what you would have paid in tax, is now in your pension fund and can be invested for your later life.
How does the whole scheme work? (with numbers and functions so I can fully understand)
Cannot answer without knowing the scheme, but most pensions are set up like this:
- Contributions are added to the pot monthly on or shortly after payday
- This is invested in a portfolio – usually a selection of funds (unit trusts or OEICs), which are pooled investments run by an investment manager. Your pension pot holds ‘units’ in these funds. The funds then buy shares or bonds or similar assets. Any growth or dividends from these underlying investments are shared equally among unit holders; charges are taken by the fund managers. This is with the aim of growing your money over the long term.
- Many pension schemes give you a choice of funds – the breadth of which, and the charges, varies from provider to provider – but since many employees either don't have an interest in their investments or don't understand funds enough to make their own choices, there is usually a ‘default fund’ which is a middle-of-the-road option designed to be diversified and not particularly high risk.
- You get a statement every year detailing how much you've paid in, how the underlying investments have performed, and – if you were to retire based on the current situation (not usually a helpful or realistic scenario until you are getting close to that age) – how much income you would typically be able to expect in retirement.
- So to sum up: your money is invested, charges are taken out every year, and how much your fund is eventually worth will depend a lot on the performance of the stock and bond markets, the ability of the underlying companies to pay dividends from their profits, and the cumulative effect of these charges. It's important to realise that this means the value of your pension pot can go down as well as up. The logical conclusion being that if things go truly terribly you could even end up with less back than you put in. However, time is your ally. Over longer timer periods, the ups and downs (volatility) in the market usually smooth out into a positive growth rate, usually higher than inflation – and, crucially, the growth rate actually accelerates over time due to the marvel of compounding.
- In other words – hopefully over the years your pension fund follows a trajectory something like this: (excuse the $ signs, couldn't find British equivalent)
When you reach retirement you decide what to do with your pension pot and when. And here we enter a whole other feast(?) of options, well beyond the scope of this answer – including but not limited to taking up to 25% of it as a tax-free lump sum, buying an annuity (a kind of insurance product designed to pay you a guaranteed and predictable income for the rest of your life), or keeping the money invested and drawing down as needed.
If this still sounds complicated – honestly, it just is. Of course it is. It's a major financial product. It's money and time, risk and return, all abstract concepts, and there are lots of choices, which you as a consumer should expect. But if you can summon the effort to look into and understand it, the incentive is a wealthier life.
What are the conditions for me to get the money (when, after how much contribution)?
It's not a matter of how much contribution, but minimum age. To qualify for tax relief, pension funds are inaccessible until the minimum retirement age. At present this is normally after you are 55, and before you are 75.
Under present rules you are able to take up to 25% of your pension pot as a tax free as a lump sum. I believe the majority of retirees take this option. Many use it to pay off what remains of any mortgage. Some use it to help the kids / grandkids with a deposit or what have you. I am sure cruise lines must also derive a fair bit of their business from this rule. NB: Tax rules can change.
What happens if I opt out – what do I get, what are the advantages and disadvantages?
What do you get? Well, see note* below, because UK employers these days are obliged to auto-enrol you in a pension scheme and pay some kind of minimum contribution. Beyond that, what you get (assuming sufficient National Insurance qualifying years) is the State Pension, which is designed to provide an income level more or less sufficient to avoid malnutrition or freezing to death – but if you’re relying solely upon that income you may have to forget about running a car, repairing the house, visiting grandchildren, going on holiday, etc.
Advantages of opting out:
If you opt out of this scheme in order to open a different private pension, you might get a wider choice of investments, or lower charges, if these are things that matter to you.
If you opt out and make no other pension plans, you will have more money to spend money now instead of saving it for later life. This assumes you will make better choices with the money at present and either don't intend to outlive your working years or believe you would tolerate a relatively impoverished retirement.
Disadvantage of opting out:
You miss out on the employer’s additional contributions. This is usually game set and match. These contributions are usually far more valuable (particularly at the earlier stages of your working life) than any
If you choose to save in other ways rather than a pension, you miss out on tax relief (see “Important Note” above). As my old boss used to say, to buy a £200,000 house costs a basic rate taxpayer £250,000 in gross earnings. But to get £200,000 in your pension costs you £160,000. That's a 45% difference. This is at 20% income tax, the difference is even starker if you move up a tax band. Sure it’s simplified, but you get the point.
In general, opting out of pension schemes runs the considerable risk of missing out on a comfortable or adequate retirement income, and only realising it when it is too late to start doing anything about it. When it comes to pension savings, time is far more of an ally than most workers realise.
In practice I don't believe it is lawful for the employer to contribute nothing, thanks to auto enrolment – see source https://www.gov.uk/workplace-pensions/joining-a-workplace-pension.