Making Cents: How important are employer pension contributions?

THIS was a question I was asked by someone recently and the trigger for them asking it was because they had just moved jobs but their new employer didn’t have a group pension plan in place and wasn’t going to either.

So, they were going to set up their own pension but they wanted to know whether not having an employer contribute anything at all was something they should be concerned about.

And there’s no doubt about it, they absolutely should.

Let me back up that statement by looking at the cold hard facts and run the numbers because I want to show you how important employer contributions are to your finances.

The person who asked me about employer contributions is 35 years old and is earning €60,000 gross per year. And for the examples I’m going to put forth, I’ll refer to him as John but just to be clear whenever I recall interactions I have with people in articles like this one, I do so in a disguised and anonymous way to protect their privacy and to protect my oath of confidentiality.

Okay, John is setting up a pension for himself and he’s going to contribute 5% to his pension fund and as you know his employer is making zero contributions.

At 65 and assuming an annual average return of 4% and that’s after accounting for inflation at 1%, this is what John’s going to have:

His fund value will be c. €173,512.

He will be able to take 25% tax free from this fund which will be €43,378.

The balance of the fund will pay him an annual gross salary of €5,205 which will be c. €429 net per month.

Contrast this with Rachel who is also 35 and also earns €60,000. She’s going to contribute 5% of her salary to her pension, the same as John, but her employer also contributes to her pension at a rate of 10%.

So Rachel has 15% of her salary going into her pension fund.

At 65, this is what Rachel is going to have:

Her fund value will be €520,537.

She will be able to take 25% tax free from this fund which will be €130,134.

The balance of the fund will pay her an annual salary of €15,616.

Which will be c. €1,288 net per month.

You can see from the above that Rachel’s numbers are 3 times bigger than John’s and that’s simply because there’s 3 times more going into Rachel’s fund every month than Johns.

And that’s all because of her employers’ contributions.

The monetary outcome of this is significant where Rachel will have:

€86,756 more tax free cash.

She has €10,411 more paid to her each year for life and she has €859 more lodged into her account each month than John.

And here’s the thing, they’ve both personally put in exactly the same amount, it’s just that Rachels employer contributed 10% and John’s 0%.

Rachel’s employers are contributing €500 per month to her pension each month and when you include what she puts in herself, it means €750 is being lodged to her account each month whereas there’s only €250 being lodged to John’s.

And that’s why there’s such a big difference between them and its why employer contributions are so important.

Also, when you look at Rachel’s total remuneration, it isn’t just the €60,000 her employer is paying her each year, they are also saving on her behalf an additional non-taxable amount of €6,000 each year as well.

So, over 30 years they are going to give her an additional €180,000.

And that’s not to say they’re giving it to her for nothing either, I’m sure it’s hard earned on her part from the work she has to do, but nonetheless over Rachel and John’s working life, despite having the same gross income, she is getting €180,000 more than him and its coming from her employer.

And if John wanted to have the same numbers as Rachel has when he retires, he would have to save an extra 10% himself, but that obviously comes at a cost to John. That cost after tax relief would see his salary decrease by €300 each month.

You can see how important employer contributions are and even if there is a relatively small difference between what employers contribute, the difference can still be substantial.

For example, I came across two more people recently, where Employee A’s employer would contribute 11% to their pension fund if they contributed 6%.

Employee’s B employer on the other hand would contribute 6% if they contributed 6%.

The overall difference between both was 5% and that 5% was coming from Employees’ A employer who was contributing more than Employees’ B.

Anyway I won’t bore you with showing you the calculations but for these two people who both had 35 years to retirement and were earning the same income (€75,000), that 5% difference meant.

Employee A was going to end up with this much more than Employee B:

They’d have €285,541 more in their pension fund at retirement.

They’d receive €71,385 more tax free cash.

They’d get paid €8,566 more every year for the rest of their life, and they’d have €707 more paid into their account each month in retirement.

And all because one employer contributed more than the other. And from the outset you might think 5% shouldn’t and wouldn’t be a big deal but you can see how it really is.

When you say 5% it seems like such a small number but if you can’t work out what that amount means and what it actually converts into from a monetary perspective, you might discount it and not give it too much thought.

But perhaps when reading an article like this and seeing what the actual impact is in euros and cents hopefully people will begin to take more notice of what’s being paid into their pension and by whom.

And those who are fortunate enough to have an employer contribute to their plan, they may begin to appreciate those contributions much more, particularly the very generous ones.

So, without going on and on you’ve got to take notice of what an employer will contribute because the outcome can be significant and you’ve also got to take notice of how much you can personally contribute as well.

For example under the age of 30 you can contribute up to 15% of your salary (capped at €115,000) to a pension fund and received tax relief on your contributions. And this percentage increases as you get older i.e. 30—39 it’s 20%, 40-49 it’s 25%, 50-54 it’s 30%, 55-59 its 35% and 60 and over its 40%.

So, whilst employer contributions are very important so are yours and if you want to retire early and/or build up enough of a pension fund that will fund the lifestyle you want in retirement, then you’ve got to take responsibility for your contributions as well and put as much in as you can.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie