Employers will not wish to allow staff to opt out of pensions, but offering schemes through salary sacrifice has cost advantages, says Laverne Hadaway
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Case Study: Kwik-fit Financial Services
Despite the poor publicity frequently surrounding pensions – the mis-selling scandals, the closure of final salary schemes and so on – they remain foundational to employee benefits.
But while pensions have never been just another employee benefit, how have they been incorporated into flexible benefits packages? Predominantly, they are a core benefit around which a flex scheme is built. This type of benefit is one that people cannot opt in or out of like other options, which can be more easily flexed. Darrell Parsons, director of employee benefits at John Scott & Partners, says: "You won’t have people saying: ‘I don’t want a pension. I’ll have three extra weeks’ holiday instead."
As Elizabeth Gibling, pensions technical manager at Chase de Vere, points out, there is little room for flexibility within pensions anyway. At present, HM Revenue & Customs rules allow only a certain level of contributions. While some employers will offer employees the option to increase or reduce pensions contribution, there is typically little leeway. The rules on contribution levels are pretty rigid: allowing a maximum of 15% of remuneration for members of occupational schemes and a range of age-related percentages for members of money purchase schemes.
However, Elliott Webster, head of flexible benefits at IFA firm PIFC, argues that national insurance (NI) savings from salary sacrifice arrangements provide plenty of incentive for firms to include pensions in flex schemes. The ease of incorporation, however, depends on the type of pension scheme. For example, while it is possible to put a defined benefit (DB) pension scheme into a flex package, it is more complex. Some employers allow members to choose different accrual rates or retirement ages, using a salary sacrifice arrangement to pay for their choice. However, there need to be actuarial considerations about the effect of those choices on the fund, how much employees should be charged and the need to amend trust deeds and rules to accommodate the changes.
Where members contribute to a DB scheme so that their contributions become employer contributions via salary sacrifice, one advantage is that the organisation will save on national insurance contributions. The scheme’s administration will also be simplified.
Defined contribution (DC) schemes are more conducive to flexible benefits schemes, because these are all about the contributions, rather than the benefits. However, Webster believes that group personal pensions (GPPs) lend themselves most easily of all to flexible benefits schemes. He suggests that a salary sacrifice arrangement should replace member contributions, so that employers enjoy the NI advantages. Members would be able to increase their contribution voluntarily by increasing their salary sacrifice at the time of year when they review their flexible benefits choices. "Salary sacrifice automatically gives GPP members their full tax relief, including the higher rate upfront. There’s anecdotal evidence that a lot of them don’t bother to claim their higher rate relief on deducted contributions," says Webster.
And by putting pensions into flexible benefits plans, employers may be able to decrease the administrative burden generated by the pension scheme. However, it is vital that employers clearly communicate the changes to staff. "Good employee communications are crucial [to ensure] understanding, a good uptake of the scheme and high employee appreciation. Get communications wrong and the flex scheme, or the pension arrangement’s part in it, could easily fail and become a source of employee dissatisfaction rather than contentment. So time, thought and money need to be spent on this aspect," says Webster.
But what of pensions simplification, yet another big legislative change concerning pensions, the beginning of which is marked by A-day on 6 April 2006? Ultimately, eight different taxation regimes governing pensions built up over the years will be reduced to one. And yet, despite the radical changes, few suggest that they will make much difference to the incorporation of pensions in flexible benefits plans.
It is true that the old contribution limits will disappear and pensions scheme members will be allowed to contribute up to £215,000 annually, as of A- day, with a lifetime contribution limit of £1.5m. But that change is not expected to make a vast difference. "There’s only so much you can flex with a pension. The way pensions are incorporated in flex, it’s all geared to contributions and these are unlikely to change drastically. A-day won’t make much difference," says John Scott’s Parsons.
The vast majority of employees are not contributing enough to their pension fund anyway and, short of a dramatic pay rise or change in their financial circumstances, they remain unlikely to increase the amount they put into their pension pot despite the changes to the contribution rules.
Some experts have speculated that the publication of annual pension statements may galvanise members into action. But others suggest that the sight of poor projected returns on their pension schemes may simply make employees bury their heads in the sand even further or lapse into apathy and despair.
Pensions simplification does give employers and trustees scope to set the contribution limits for schemes, within the new rules. However, they will usually look to set a limit on their own expenses. So they may choose, for example, to match employees’ contributions, make a fixed level of contributions across the board or even offer a non-contributory pension. None of these options are anything new, but nevertheless, employers will be able to review what they want to offer employees and there is likely to be broader flexibility.
The biggest potential for change may come with those at the top level of employment, who either already pay the maximum contribution or are near or at the lifetime allowance limit. Whereas employers have been reluctant to let staff opt out of pension scheme membership altogether, they will have to do something for those in danger of breaching the allowance. Employers will have to come up with an alternative package of benefits for senior employees caught by the new limits. As Parsons points out: "If you’ve reached the lifetime allowance, there’s no point putting any more money in." He also believes that many of these senior executives are tired of the often restricted investment flexibility of in-house pensions anyway and would prefer to broaden the scope of their pension investments. Where pension schemes are included in flexible benefits, one option open to employers is to compensate these employees by adding the amount that would have been paid in pension contributions to their flex fund to spend on other benefits.
But the lifetime allowance is only likely to ever affect a minority of employees. David Thurlow, a director of Atkinson Bolton, comments that for everyone else: "Pensions in flex have always been one of the most important packages and final salary schemes are the big ticket pensions."
Case Study: Kwik-Fit Financial Services
Kwik-Fit Financial Services enables staff to use their flexible benefits allowance to top-up their pension pots with a one-off annual contribution. If staff choose to do so, the company also contributes the resulting national insurance (NI) savings to their defined contribution (DC) fund.
Keren Edwards, HR director, explains that this is aimed at encouraging younger employees to save: "What is important to us is that we have got quite a young workforce and we’ve got to take responsibility for educating them."
She adds that passing the NI savings on to employees is a key hook because pension contributions offered through any other type of arrangement are not tax advantageous. In turn, employees that take up the option receive more for their money. "None of the other benefits are incentivised in this way," says Edwards.
The option was added to the company’s flexible benefits scheme’s for the election period in November last year when 60 employees chose to take it up. Edwards adds that it gave it a strong communications push in order to boost take up.
However, she acknowledges that the workforce’s young age profile means they may not always recognise the need to begin saving for retirement. "Short of sitting over them and forcing them to [choose] it, there’s not a lot else we could do. I can’t put old heads on young shoulders," she adds.
Pensions: the broad facts
1. While pension schemes can be incorporated into flexible benefits plans, they are most likely to be one of the core benefits around which the rest of the flex scheme sits.
2. Some pension schemes are more easily incorporated than others. Defined benefit schemes, for example, will require actuarial considerations, depending on the accrual rates and retirement ages chosen.
3. There are national insurance savings to be had for employers where members’ pension contributions are made via salary sacrifice arrangements.
4. While members may be able to contribute more to their pensions or buy added years, few employers will allow them to opt out altogether in return for an alternative benefit.
5. After A-day, employers may have to look at providing alternatives to pension benefits for senior executives at or near the lifetime allowance.