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.”
Although designed with low-paid staff in mind, employers can enrol their entire workforce into NESTand contribute more than the minimum if desired. They must therefore choose whether they wish to use NESTor 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 intoNEST, 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.
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 NEST, which will be launched to provide access to a low-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.
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.
How to prepare for October 2012
- Decide which type of pensions provision to make for staff from 2012 - NEST 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.
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.
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.”
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. 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.
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.
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.