2012 Pension Reforms: Start getting up to speed

If you read nothing else, read this …

• Employers should budget now to manage the extra costs of all staff automatically enrolling into a pension scheme with compulsory minimum contributions.
• Employees earning more than the personal income tax allowance of £7,475 will be automatically enrolled into a pension scheme from 2012 onwards.
• Initially, employers will pay 1% in pension contributions, but this rises gradually to 3%.
• It is proposed a three-month ‘waiting’ period be introduced in which staff are not enrolled automatically but can opt in if they want to.

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Case study: Capital One in credit on auto-enrolment

Capital One is well ahead of the game in preparing for 2012 – it has already introduced auto-enrolment and auto-increases.

Working from the premise that the credit card firm’s staff should be encouraged to save more for their retirement, its pensions governance committee decided to introduce an arrangement whereby employee pension contributions automatically increase by 1% each year unless staff choose to opt out.

At its group personal pension’s (GPP’s) most basic level, staff are given a 5% employer contribution, but if the employee contributes 3% of salary, Capital One will match this amount, bringing the total contribution to 11% of salary.

Matches will always be based on a 5% contribution, and if the employee puts in 7%, they will obtain the maximum contribution of 10% from Capital One, bringing the total to 17%.

The firm also allows staff to make extra contributions into their scheme halfway through the year.

Jill Cunnison, operations manager HR, is confident that the company will not need to make significant changes when auto-enrolment comes in 2012.

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The new government has given the 2012 reforms the green light, but some details still need finalising, says Nicola Sullivan

The previous Labour government introduced the Pensions Act 2008 which, from 2012 onwards, will bring in several pension reforms that aim to boost employee retirement savings and bring seven million more people into the habit of saving for retirement through the workplace.

When the new coalition government came to power this year, it decided to review these reforms, in particular those pertaining to auto-enrolment and the national employment savings trust (Nest). The review report, Making auto-enrolment work, was published by the Department of Work and Pensions (DWP) in October and brings to an end the planning blight among employers anxious to get on with preparing for the 2012 reforms.

However, a number of details are still at the proposal stage. Legal and General’s pensions strategy director, Adrian Boulding, who was seconded to work on the review, says: “Although the legislative changes have yet to be enacted, the government has set a clear direction and it is now the right time for employers to plan their implementation.”

Compulsory auto-enrolment will be enforced from October 2012 onwards, with workforces brought in gradually over a four-year period, with the largest going first (see page 6). Under current proposals, staff earning more than the personal income tax allowance of £7,475 will be automatically enrolled into a scheme at the relevant date.

Pension contributions

Compulsory employee and employer pension contributions will also come in gradually. Initially, employers and employees will each have to contribute just 1% (see page 8 for full details), so employers that currently do not make any pension contributions for large numbers of staff now need to start budgeting to meet these extra payroll costs.

Employers that want to continue offering their existing pension schemes have to meet minimum requirements, and if they do not, their staff will automatically be defaulted into the new Nest scheme.

The government is simplifying the process by which employers can self-certify their defined contribution (DC) scheme to be exempt from Nest. As the proposals stand, employers will be able to retain existing workplace pensions if they meet one of three criteria relating to how contributions are calculated as a percentage of pay.

Here, the review has taken into account the fact that many workplace schemes, unlike Nest, do not use ‘band earnings’ (which include bonus, overtime and commission) to calculate contributions. Most use ‘basic earnings’, which refers to monthly or hourly pay, excluding variable pay or bonuses.

Employers will still be able to use basic earnings as long as the overall pension contribution is at least 7% of earnings, although if they opt for 7%, they will have to certify that 100% of total earnings are basic earnings. If they choose to use 8% of basic earnings, they have to certify that at least 85% is from basic earnings. Both these options require a 3% employer contribution.

Alternatively, they can use a contribution of 9% of basic earnings – of which 4% comes from the employer and 5% from the employee – and in that case they do not have to certify the level of basic earnings at all.

Laith Kalaf, pensions analyst at Hargreaves Lansdown, says: “Self-certification is very important because it means employers are not discouraged from keeping their existing schemes and just thinking ‘OK, we have got a good scheme and if we contribute 6% to it, for instance, but do not include commission or overtime, maybe we are not compliant’, [so] packing in a good scheme and saying ‘we will just go into Nest and contribute 3% of band earnings’, which will be a bad outcome for the employees in that scheme.”

Nick Frankland, principal in Punter Southall’s DC consulting team, adds: “You can dispense with massive detailed checking of all members and look at your scheme as a whole and the rules you use to calculate pension contributions. Provided it meets one of those criteria, you can certify the scheme as being adequate.”

Another aspect of the review that pleases the pensions industry – and will keep a cap on employer costs – is the yet-to-be confirmed proposal to include a three-month waiting period during which employees are not automatically enrolled but can voluntarily opt into the pension. Kalaf says: “This means if an employer has got people who are in the workplace for a very short period of time, they are not auto-enrolled. It also gives employers time to inform those employees of what is going to happen in advance of it happening, rather than them arriving on day one and already having earnings deducted for a pension they are not aware of.”

Steve Watson, head of DC at Alexander Forbes, adds: “It is those organisations that rely on seasonal workers that were becoming particularly concerned, not about the cost but the administration.”

Despite the later staging dates for smaller employers to implement auto-enrolment and the related compulsory contributions, some small and medium-sized enterprises (SMEs) may still find the process challenging. Paul Goodwin, head of pensions marketing at Aviva, says: “If you take an engineering business with 40 or 50 employees, it is likely to have been set up by an engineer who will be an engineering specialist. It will outsource things like payroll and will not have a large HR department so will not have a pensions manager. This will all be new for employers that do not have a scheme in place.”

Many in the pension industry think the simplicity of using the Nest scheme will make it a lot easier for smaller employers, however.

Small businesses

Tom McPhail, head of pensions research at Hargreaves Lansdown, says: “Much concern centres on small businesses and how they are going to comply with the regulations. However, I am optimistic. I think some employers will use private-sector solutions, but those that do not and look to Nest will find it pretty straightforward.”

Watson says some organisations with no employer-paid pension may choose to adopt Nest as soon as they can. The Nest Corporation has confirmed the scheme will be open for early adopters in 2011.

“Organisations that either have a small take-up or have not offered pensions across the board will start taking up Nest earlier to get the credibility of offering a pension rather than waiting until it is perceived to be doing so only because it has to,” says Watson.

Goodwin adds: “There is no doubt auto-enrolment will increase take-up, but it will not necessarily enable engagement. A lot of people will join schemes only because they have been auto-enrolled, and that does not necessarily mean they are engaged.”

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Employees can opt out

Employees can opt out of a pension scheme one month from the day they are told they have been automatically enrolled into it. The Department of Work and Pensions estimates 25% of staff will opt out during this period. Those not in a pension scheme will be automatically re-enrolled every three years.

All pension contributions paid by an employee who opts out must be refunded. Current regulations stipulate that the opt-out form must be obtained by the employee from the pension provider, except where the scheme’s trust deed delegates administration to the employer. Although the final details are yet to be settled, the government is steering towards maintaining some distance between the employer and the opt-out decision. The report reads: “Employer pension contributions are now a statutory right for employees, yet new employees often feel the least comfortable at asking for their rights and are the most susceptible to pressure from their employer.

“Keeping the opt-out form separate from the employer will avoid the risk of even well-intentioned employers accidentally creating an atmosphere in which a new employee feels that opting out would be a good thing to do for the finances of the business.”

Another alternative being considered is to make opt-out forms available from a central source, such as a link on the Directgov or DWP website.

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Get into gear now for a new era in workplace pensions

Six steps to compliance

How to budget for auto-enrolment

Protection of the Nest