The introduction of personal accounts (PA) in 2012 may seem like yet another periodic reorganisation of the British pension system, but finance directors should not underestimate its potential impact.
PA were first recommended by the Pensions Commission, led by Lord Turner, as a way to boost pension provision among the low-paid and those without access to an occupational pension scheme. The government has followed up with legislation on this in the Pensions Bill 2008, which is currently making its way through Parliament. The bill is expected to reach the statute books in November, but many of the details will only become clear when supplementary legislation is published.
The Personal Accounts Delivery Authority (Pada) has been set up to consult with pension providers, financial advisers and others on the detailed workings of PA.
What is known is that the PA system will be a multi-employer defined contribution (DC) occupational pension scheme intended to complement, not replace, existing occupational schemes. It will be a ‘one-size-fits-all’ arrangement and transfers in from other schemes will not be permitted.
From 2012, all employees aged over 22 but under the state pension age will have to be auto-enrolled into either an employer’s existing pension scheme or into the PA scheme.
Employees will have the right to opt out, but there will be periodic re-enrolment exercises. Employers will have to contribute a minimum of 3% of annual earnings between £5,035 and £33,540 (to be up rated in 2012), with staff contributing a minimum of 4%, and a further 1% being added through tax relief on the employee contribution. Existing pension schemes will have to at least match these minimum contribution levels if employers are to gain exemption from offering PA. And the proposed contribution levels will be phased in to limit their immediate impact.
The charges for PA have yet to be decided. Some expect to see an annual management charge (AMC) and a contribution charge, although Pada is still consulting on this. Jardine Lloyd Thompson chief executive Duncan Howorth says: “I would be surprised if there was a contribution charge. There will be some fairly low levels of contribution. There is no point having a contribution charge unless it is meaningful.”
Lord Turner’s original AMC goal of 0.3% has been derided as unrealistic by some, but Howorth says: “I would not be surprised if it is under 0.5%”, adding that existing DC schemes for large employers with simple investment options are priced as low as 0.4%.
Hewitt Associates senior consultant Andy Cheseldine adds that FDs needed to start planning now. “By definition, if you are not contributing to pensions, it is going to add 3% to costs. If you have a relatively typical contribution rate of 6%, but with only one-third of the workforce enrolled in a pension scheme, PA will double your pension costs.”
Towers Perrin principal Mark Duke says: “If I was an FD, the first thing I would ask is how many people do I have in my existing plan? If there are a lot of people who don’t join, how much it is it going to cost me?” Gary Cullen, Maclay Murray and Spens pensions partner and head of pensions practice, says: “For employers with schemes offering contribution above the PA minimum level, is the employer going to say ‘let’s phase out more generous schemes and pay in the minimum’? There might be levelling down.”
In deciding how to respond to the challenge of PA, Cheseldine says that a fundamental issue for employers is to decide what kind of employer they are. “Do they want to differentiate themselves, post-personal accounts, on pension provision? Is it going to be an advantage to say we have a better pension than PA?” According to Clerical Medical regulatory liaison marketing manager Stewart Mason, 37% of employers said in a recent survey that they would be unaffected by PA. “I think they are being incredibly optimistic. Most companies will have to review their schemes and make changes. Even if they have a good scheme, they can’t just ignore this.”
A couple of examples illustrate Mason’s point. Ian Naismith, Scottish Widows head of pensions market development, points out that most schemes have a minimum salary or age before employees can join: “They need to check their criteria for joining matches those for PA. A lot of schemes have a waiting period, and PA start immediately, but the government is going to allow a three month waiting period but with a higher contribution rate than the minimum.”
Another issue is that PA contributions are to be based on total earnings, whereas many existing schemes use basic pay, excluding bonuses and overtime, to calculate contributions. Mason warns: “5% of basic salary might be less than 3% of total earnings.”
In summary, PA will bring some fundamental changes to workplace pensions. FDs need to look at how their existing arrangements meet the PAs criteria and start planning and budgeting.