Updated on 10 Decemember 2012:
For the most up-to-date facts, analysis and news please go to our dedicated pensions auto-enrolment section.
Read Special report on auto-enrolment (written December 2012)
Updated on 15 January 2012:
Read updated reports on how to prepare for the 2012 pension reforms:
News:Government confirms new staging dates for auto-enrolment (written January 2012)
Special report: Employee Benefits/Benefex pension reforms (written October 2011)
Special report: 2012 pensions reforms (written December 2010)
The report below was written in February 2009, therefore some legislation details have changed slightly. Please go to the dedicated pensions auto-enrolment section on our website for more up-to-date insights.
Employers can take steps now to prepare for 2012’s pensions reforms, says Katrina McKeever
Key points of the Pensions Act 2008:
- The Pensions Act will take effect from 2012 and will be gradually introduced depending on employers’ size.
- All employers must offer a qualifying workplace pension scheme and automatically enrol eligible employees. Those who do not must enrol staff into the system of personal accounts, which will be launched to provide access to a lost-cost pensions vehicle.
- At least 8% of an employee’s qualifying earnings must be paid into a pension, which is made up of 3% employer contributions, 4% employee contributions, and 1% tax relief.
- Staff will be allowed to opt out of schemes, in which case, employers will no longer be liable for paying employee contributions.
- Employers will be able to self certify that their existing workplace pension schemes meet the minimum requirements set out by the act.
How to prepare for October 2012
- Decide which type of pensions provision to make for staff from 2012 – personal accounts or an existing scheme.
- Examine existing pension schemes to determine if they will meet the minimum requirements set out by the act.
- Consider the cost impact of the compulsory 3% employer contribution.
- Ensure payroll and HR systems are able to cope with the extra administration.
Read also: Preparing for auto enrolment ahead of 2012
Full article: How employers can prepare for 2012 pension reforms
The Pensions Act 2008, which is due to come into effect in 2012, will, for the first time place a legal duty on employers to enrol most employees into a pension scheme and contribute towards their retirement. The move is aimed at getting an estimated seven million extra workers saving for retirement. Secretary of state for work and pensions, James Purnell, says: “This act will fundamentally change the pensions’ landscape for millions of people. If you are in some form of employment, you will have the chance to save for retirement.”
As the countdown to the changes continues, employers must ensure they are ready to meet their obligations. When the act comes into effect, the changes will be phased in over three stages depending on the size of an organisation based on PAYE payroll data. Although the exact dates have yet to be determined, selected larger employers will be required to comply first, followed by small- and medium-sized organisations and, lastly, by the smallest employers.
Which staff will be affected?
The need to phase in the changes reflects the enormity of the task. Going from simply providing access to a pension scheme to staff to being required to enrol all employees aged between 22 and 75 years, who earn between £5,035 and £33,540 a year based on current pay levels, will be a huge undertaking for employers. Staff aged 16-to-22 years can also opt in to pay employee contributions. The auto-enrolment is designed to make it as easy as possible for employees to participate in pension schemes and overcome the inertia that often prevents them from joining.
To help employers comply with the regulations, personal accounts, a type of trust-based occupational pension scheme has been introduced under the act. Tim Jones, chief executive of the Personal Accounts Delivery Authority (Pada), says: “The personal accounts scheme is being created to provide a low-charge, independent, workplace pension scheme that any employer can use, should they choose to do so.”
Although designed with low-paid staff in mind, employers can enrol their entire workforce into personal accounts and contribute more than the minimum if desired. They must therefore choose whether they wish to use personal accounts or another qualifying workplace pension plan. If employers wish to continue providing the benefit themselves, they must decide whether to enrol new members into an existing scheme or open a new pension plan to satisfy their new obligations.
If employers wish to continue providing an occupational pension scheme, rather than enrolling staff into personal accounts, they must prove it provides at least equal benefits. The exact criteria a plan must meet to qualify will be set out in future regulations.
Existing pension schemes
In the case of defined benefit (DB) pension schemes there are two ways they will be able to do so. All DB schemes that have contracted out of the state second pension and hold a valid contracting-out certificate will pass the test. Others must meet a hypothetical benchmark accrual rate of 1/120ths of average qualifying earnings in the three previous years. Jane Beverly, head of research at Punter Southall, says: “Virtually all defined benefit schemes in the country will meet the criteria, which is a 1/120th accrual rate, whereas 1/60th or 1/80th is much more common.”
Employers that operate open final salary schemes will be allowed to phase in employees who were not previously members. The majority of pension schemes that are open to new members, however, will be defined contribution (DC) schemes, such as trust-based, group personal pension (GPP) or stakeholder plans.
The exemption criteria for DC schemes will largely be based on contribution levels, namely 8% of qualifying earnings of employees. This will be phased in across three tiers, beginning with both employers and employees contributing 1% of qualifying earnings, then employers 2% and employees 3%, and finally employers 3% and employees 5%, inclusive of basic rate tax relief.
This could have a large cost implication for some employers, particularly small ones, says Paul Macro, principal at Watson Wyatt. A survey conducted by the firm, due for publication this spring, shows that the current average contribution for FTSE-100 companies is about 15%. “Most [larger organisations] will not have a problem,” he says. “For smaller organisations the headline rate is much closer to the 8% figure and many [put in] less than that.”
Temporary and contract workers
Steve Charlton, a principal within the retirement business at Mercer, adds that some sectors, such as retail and construction, will face greater challenges than others, because they traditionally have a transient workforce, high staff turnover and low take-up of pensions. “They [will] suddenly have to find the cash for a much larger pensions bill,” he says. “They may be able to rely on some people opting out but the auto-enrolment element [of the act] is banking on inertia preventing staff from doing this.”
The act’s definition of eligible employees also includes agency workers, fixed-term and part-time contract workers, and anyone who undertakes work in Great Britain, whether by written or oral contract. This means employers will need to pay contributions for workers, such as contractors, who did not previously qualify, says Charlton. Employers should, therefore, factor this into decisions, such as pay awards now. “We are moving towards a recognition of total reward,” he says. “[You can tell employees] their pay rise is 2% but 1% is going toward pensions.”
However, there are signs the Department for Work and Pensions, PADA and the Pensions Regulator, which are responsible for implementing the reforms, have been listening to employers’ concerns about whether their schemes would qualify. This was evident in last year’s announcement that the act will contain provisions to allow employers to self-certify their scheme meets the quality standard based on the expected value of contributions to be made each year once the reforms come into effect in 2012.
Richard Wilson, a senior policy adviser at the National Association of Pension Funds (NAPF), says the aim is to make self-certification as easy as possible to avoid employers having to pay large fees for scheme reviews. It is intended to support employers that currently provide good schemes and want to keep them running. “While [the NAPF] is broadly supportive of personal accounts and the Pensions Act, our key concern is to prevent this resulting in a levelling down of pension schemes that exist out there. That would be a disaster for pension savings in this country if that were to happen so we have to be very vigilant against this.”
Although some employers may take the opportunity to cut back their current pension contributions down to the required minimum set out under the Pensions Act, others will take a conscious decision to offer higher contributions in a bid to stand out as an employer of choice. They will take the view that offering a scheme above the benchmark will help attract and retain talented staff, says Wilson.
With much of the guidance and regulations concerning the act still to come, the devil will be in the detail. However, there are several significant changes that employers can begin to consider.
One such change concerns the definition of qualifying earnings, which will differ from the way most plans currently calculate pensionable salary, by also including variable elements such as bonus, overtime and commission payments. “If you have employees with lots of variable earnings, lots of overtime and bonuses, then 8% of basic pay may be less than 8% of earnings,” says Macro.
Another issue that will require attention is auto-enrolment. From 2012, employers cannot require employees to make any choices, or ask them to provide information to join the scheme, for example, they cannot make it mandatory for staff to make investment choices. This means employers must ensure their default investment fund is up to scratch. The act also dictates there should be no deferred period before staff join a scheme, which could place a greater administrative burden on employers and requires them to be more proactive. They must therefore ensure human resources and payroll systems are able to cope with increased administration.
Auto-enrolment also rules out seeking employees’ consent to make deductions from pay, which could throw up secondary issues regarding salary sacrifice arrangements on pension contributions. This could be particularly important as some employers will look to such arrangements to offset the increased costs associated with implementing the reforms. One way around this is to reword employees’ contracts of employment to establish the principle of salary sacrifice for appropriate salary levels.
Employers which include pension schemes within a flexible benefits plan also need to consider whether any of their terms could be seen as inducement, or action taken to encourage employees to opt out of the pension scheme. For example, employers that offer staff the choice of flexing out of employer pension contributions to spend the money on other perks may need to revise this strategy ahead of 2012, says Beverly. “Offering alternative benefits to the 3% minimum contribution could put [employers] at risk of contravening the new regulations. A way around this is to offer other benefits, in addition to the 3% minimum, in such a way that is not mutually exclusive,” she adds.
Starting to prepare for the reforms now is a good idea. Beginning sooner, rather than later, will enable changes to be broken down into smaller, more manageable tasks rather than waiting for the pensions regulator to begin contacting employers directly, which it is scheduled to do from 2011.
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