Many employers have been reluctant to include pensions in their flex schemes, but there are advantages in doing so, says Katrina McKeever
Over the past two decades, as flexible benefits schemes have grown in popularity in the UK, employers have generally fought shy of including pensions within flex.
Traditionally, they have cited the inability to increase or decrease final salary contributions; fears of staff reducing or opting out of contributing to defined contribution (DC) schemes; and a lack of integrated flexible benefits and pensions administration systems; as some of the many complex hurdles to overcome.
But, this year, the pensions and flex landscape looks very different from the early 1990s. Few employers still offer final salary schemes, the idea of flexing or capping benefits choices is common, and technology has come on in leaps and bounds.
Some now believe that because pensions are such a fundamental part of benefits packages, any employer seeking to launch a flexible benefits strategy will want to place their occupational pension scheme at the heart of it. Gareth Ashley-Jones, head of flexible benefits at Aon Consulting, says pensions and flex fit like a hand in glove. “Bearing in mind it is such a major benefit to employees, it is right to be in the flexible benefits scheme,” he says.
There are several key advantages to including pension schemes in flex. One of these is the way flex can focus employees’ attention on pensions. “Flex is a way of raising the profile of the pension,” says Ashley-Jones. “When people join the company, they get a pension pack and they do nothing with it. They think ‘I will only be here for one or two years’ and 10 years later they are still there.”
If a pension is provided through a flexible benefits scheme, staff are confronted with the need to make a decision about their pension every year when they make their flex selections.
This is not the only way flex can engage staff in pensions. Flex technology commonly allows employees to try out different benefits selections using online calculators and modelling tools before making their final selections. By incorporating pension calculators in flex, staff can also see the long-term financial implications of not saving for retirement, which may prompt them to join the pension scheme.
Lee French, proposition director, defined contribution at Alexander Forbes Financial Services, says the technology can also show staff the full value of their choices by highlighting the tax advantages of joining the pension.
It is not only employees who can benefit from easier access to pension tax breaks through flex as employers can gain too. This is due to the fact that organisations do not pay employers’ national insurance (NI) on their pensions contributions for staff. However, they would pay employers’ NI on any salary used by staff to make employee contributions. Through flex, employers can set up the benefits choices so that all pension contributions become employer contributions.
By doing this, employers stand to save 12.8% in NI contributions (NICs), which can be used, at least in part, to fund the flex plan. Staff can also save up to 11% in NICs for basic-rate taxpayers or 1% for higher-rate taxpayers. Ashley-Jones says: “The NIC savings through salary sacrifice are very substantial from the employer’s and from the employee’s angle.”
This access to NI breaks can be expanded by including staff who are not in the flex scheme, allowing them to sacrifice a portion of their pay in exchange for the employer making pension contributions on their behalf.
If employers are going down this salary sacrifice route, it is crucial to make sure the scheme complies with HM Revenue and Customs’ (HMRC) rules. Clive Cripps, employee benefits specialist at Hewitt Associates, says: “HMRC queries genuine changes to employment contracts and employers risk getting into trouble if they have not collected all the paperwork. By doing it through a flex system, the employer has the employee’s electronic signature, so it is a much easier way of ensuring the employer has met all the legal requirements. The administration for flex will be the administration for salary sacrifice as well.”
Regardless of the tax and NI breaks around pension contributions, the vital factor is how much employees are saving for their retirement. Cripps says many employers have a paternalistic view of their pension and want to provide a good retirement for their workers.
In particular, employers that provide defined benefit (DB) schemes may want to protect staff from making rash decisions to flex out of the scheme and opt for more cash pay instead. But this does not mean employers should exclude pensions from flex entirely. They can use a number of options to increase flexibility around retirement savings (see box, p24). They can ring-fence a DB scheme outside of flex, but still display it on the flex platform so staff can view it as part of their total reward. Employers could also include added voluntary contributions (AVCs) within flex choices.
Another option for employers offering DC pensions, which want to protect contributions levels while still offering choice, is to offer staged contributions. Under this option, employees flex contributions according to a set range of matching choices. For example, they may select an employer contribution of 3% with a matching employee contribution of 4%, or they could select an employer contribution of 4% with an employee contribution of 5%.
In the next few years, there are several issues to keep in mind about pension contributions. The Pensions Act 2008, which comes into effect in 2012, places a duty on employers to enrol almost all staff into a pension scheme and pay a minimum level of contributions.
This may throw up challenges for some current flex plans that allow maximum flexibility around pensions. The new Act will prohibit any move to encourage employees to opt out of a minimum pension contribution level, which will increase over several years to 3% from the employer and 4% from the employee.
“One way around this may be to have a core contribution level that you can’t go below,” says Alexander Forbes Financial Services’ French. “Anything you want to flex beyond this should be upwards and not down.”
Experts agree that employers which provide staff with flexible benefits and pensions, in whichever form they take, are likely to be best practice organisations and so are likely to uphold the spirit of the 2012 legislation.
With such potential changes to contribution levels looming, employers with good administration systems behind their flex schemes will be relieved to realise that flex can reduce their administrative burden. The processing of all pension applications and alterations to contributions can be done online, without additional paperwork. It can even be processed right through to the pensions provider.
But several issues will require a manual overview from the HR department, including checks that minimum wage levels are not breached if staff opt for a salary sacrifice arrangement on their pension contributions.
French says an initial sift of employees will ensure those on the national minimum wage are excluded from any choices involving salary sacrifice to stop them reducing their salary below the legal level. “An administration team will need to review the choices,” he adds.
Supporting management information available from the online platform is also an advantage, allowing easy, instant access to data, such as take-up rates. This helps benefits managers to contact staff who have not joined during the enrolment period and encourage them to sign up, says French.
From the employer’s perspective, the move to provide pensions through a flexible benefits platform should be straightforward, and highly beneficial to all parties.
Case Study: Zurich Financial Services
Zurich Financial Services operates a trust-based defined contribution (DC) pension plan through its flexible benefits scheme.
The 1,373 DC plan members have been able to access their pension through the flex scheme since April 2007, when Zurich closed its defined benefit pension to new members. Now all new staff can enrol into the DC scheme online through the flex plan.
Pete Steer, UK HR payroll and benefits director, says the scheme has almost 100% take-up. “The whole pension is integrated into the flex system so that when people are either starting with us, or every year when they choose their benefits, they have a chance to review and amend their contributions,” he says.
The 6,519 members of the final salary scheme, which is operated by the same trust as the DC plan, can also opt to make additional voluntary contributions to their pension savings by paying into the DC scheme through flex.
Staff in both schemes can make pension contributions through salary sacrifice, saving on tax and national insurance. They can also make a one-off payment into their DC scheme each year, for example, to pay in a corporate bonus.
Linking savings through flex
Several providers have launched online flex platforms that allow staff to put savings into a variety of products, from pensions and share schemes to individual savings accounts (Isas) and savings accounts.
Several more flex providers are thought to have similar platforms in development, capitalising on the interest in broader employee wealth management and the need to offer a variety of financial options. For example, some staff may be better paying off student debt than saving for a pension. New integrated savings products meet this need.
Gareth Ashley-Jones, head of flexible benefits at Aon Consulting, cites pension contributions that can be integrated with a first home purchase product. Here, staff who join the pension scheme can divert part of their employer’s pension contribution into a savings account for a fixed period. This is available only to pension scheme members and the money must be used for a specific product, for example, buying a first home.
This way, employees get something in the medium term as well as when they retire, which can be a powerful staff retention tool.
Similar options can be set up to pay off debt, student loans, or save into Isas.
Click on the links below for more sections:
Who are the respondents; key findings
Attitudes to flexible benefits
Structure of flexible benefits schemes
How flexible benefits schemes are administered
Salary sacrifice in flexible benefits
Alternatives to flex plans
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