Next year will witness the end of the world, if you believe the ancient Mayan calendar. If on the other hand you don’t, you need to prepare for arguably the biggest shake-up in workplace pensions since they were invented. Laith Khalaf, Pensions Analyst at Hargreaves Lansdown
The first organised workplace pension in the UK was set up in the 17th century by the Royal Navy. Now, 300 years later, the pension obligations of employers towards their staff are fundamentally shifting. Pension provision will no longer be a voluntary matter, rather employers will have to offer a pension to their workforce and, critically, to make payments into it. This goes much further than the employer access rules introduced in 2001, which required employers with 5 or more employees to make a Stakeholder pension available to their staff. Back then the hope was that this rule would create a groundswell of retirement saving.
The result was underwhelming in the extreme. Where Stakeholders were offered they often came with no employer contribution and take-up was low. Policymakers gathered into a huddle and came back with a new plan: automatic enrolment. Automatic enrolment will use the attested inertia of employees to get them saving into a pension. Employers will be obliged to enrol their staff into a pension, with personal contributions deducted from their pay. Employees will be able to opt out of the pension arrangement if they wish, but by making them fill in a form to opt out rather than to join a pension, millions more are expected to start saving for their retirement. That’s the theory anyway. Employers will also have to contribute to the pensions of staff who don’t opt out. The minimum employer contribution will be three percent of qualifying earnings, on top of a minimum of four percent coming from the employee and one person coming from the government in the form of tax relief. It is often incorrectly said that these contributions will have to be made into a new pension scheme set up by the government called NEST (the National Employment Savings Trust). ‘From 2012 employers will have to automatically enrol their staff into a new pension scheme called NEST’ numerous commentaries have recounted. However this statement confuses NEST with automatic enrolment, which are in fact two distinct things. The truth of the matter is that from 2012 onwards employers will have to automatically enrol staff into a pension scheme which meets certain standards. NEST will be but one of the options available to employers. Final Salary schemes, Group Personal Pensions, Group SIPPs (Self Invested Personal Pensions) and the new breed of Corporate Wraps can all be suitable schemes for automatic enrolment too.
NEST will be a cheap, no frills option which is likely to be adopted by firms who simply want to tick a box with little regard for getting value for money from the contributions they are making into their employees’ pensions. That could potentially be a lot of companies. Half of employers do not think their staff appreciate the pension contributions made on their behalf, according to a recent survey conducted by Hargreaves Lansdown. This echoes similar research findings from the Department for Work and Pensions. If you think about this in cash terms it equates to £21 billion of pension contributions which private sector employers think they are pouring down the drain. Automatic enrolment is likely to raise the stakes here: more pension ‘joiners’ means more contributions, other things being equal. More automatically enrolled ‘joiners’ means a greater proportion of unappreciative savers, other things being equal.
Automatic enrolment could therefore create millions of accidental pension savers, temporarily aggrieved that their take home pay is less than it was and largely oblivious to the pension contributions being made by their employer. The challenge for HR practitioners therefore will be to engage workers in the retirement savings process and to communicate the value of the pension contributions which the employer is making. The 2012 pension reforms are almost inevitably going to cost companies money, so success will be measured by what that money achieves. Effective communications could range from providing staff with an annual statement of contributions, to making online tools available, through to arranging group seminars or one-to-one advice. Some communications can be arranged in-house while some will be left to the pension provider or intermediary. This throws the spotlight onto the package of education and advice that providers and advisers offer as part of the group benefits arrangement. Employers who are able to engage their staff in the savings process stand to reap some reward from the contributions they make, while doing their staff a valuable service in the process. The alternative is tipping money into a black hole of indifference.
Employers won’t necessarily have to adopt an entirely new pension scheme to meet their new responsibilities. Workplace schemes which are already in place may well be suitable for automatic enrolment, or more likely may be adapted to become so. However a review is still necessary in order to assess compliance, which in itself may lead to a fuller root and branch examination of existing pension arrangements and the value they are providing both to employer and employee. Such reviews need to be undertaken well in advance of the arrival of automatic enrolment, indeed HR teams and Finance Directors need to start thinking about this now.
Existing pension schemes may need to be modified in a number of ways. For instance existing pension schemes which restrict membership based on age will need to be revised if they are to be used for automatic enrolment. This is because all employees between 22 and state pension age with earnings of more than £7,475 will need to be enrolled into the scheme. What is more employees aged 16 to 22 or above state pension age but less than 75 must be allowed to opt in if they wish. Age restrictions will almost certainly have to go therefore. Employers will also need to be able to identify when existing employees become eligible for automatic enrolment, either in virtue of reaching age 22 or breaking through the minimum earnings threshold.
The definition of ‘qualifying earnings’ also raises problems which need to be addressed by employers in advance of the new rules becoming effective. The legislation requires a pension contribution of eight percent of ‘qualifying earnings’, with a minimum of three percent from the employer. However the way the legislation defines ‘qualifying earnings’ is at odds with the pensionable earnings used by most group pension schemes. ‘Qualifying earnings’ are defined as those earnings between £5,715 and £38,185; most existing schemes will simply count pay as pensionable from the first £1 upwards. On the other hand qualifying earnings will include not just basic pay but also overtime, bonuses, and commission, which are typically excluded from pensionable earnings.
Achieving compliance won’t therefore be as simple as making a contribution of three percent of basic pay into an existing scheme. The government has however made some concessions to simplicity here which will allow employers to certify that they meet one of three alternative tests if their scheme doesn’t mirror the artificial notion of ‘qualifying earnings’. The most popular of these three options will allow schemes to use basic pay as usual, provided a slightly higher contribution of nine percent is made, of which four percent comes from the employer.
HR teams must also address the question of waiting periods within their pension scheme if they wish to continue to use it; within around a third of schemes employees do not get offered membership until they have completed a certain period of service. Or it may be that staff are offered membership once a year on a specific date. Either way these policies will need to be reviewed to comply with the new rules which will require employers to wait no more than three months from an employee starting work before enrolling that individual into a pension scheme. During this period employees must be permitted to opt in, so even an existing scheme operating a three month waiting period which does not allow them to do so will still not be fully compliant. These are just some examples of the questions which need to be addressed in advance of the new regulations taking effect. Clearly a fairly in depth scheme review will therefore be needed to pick up on this kind of detail and the more time which is given to conduct such a review before automatic enrolment arrives, the better. Automatic enrolment is actually being phased in, which allows a small amount of breathing space, depending on the size of the company. Only the largest employers will have to comply with the regulations when they land in October 2012. Other firms will then follow in order of the number of staff on the payroll, those with the most first. By July 2014 all employers with a payroll of more than 50 employees will need to comply with the regulations. Employers with less than 50 staff will then be phased in by February 2016. A full list of relevant dates is available on the website of the Pensions Regulator.
The Pensions Regulator will be writing to firms 12 months before their auto-enrolment date to notify them of their imminent obligation to automatically enrol their staff into a pension. Companies which have taken stock in good time won’t have to hit the panic button when this notice arrives. It is also possible to bring forward your automatic enrolment date which some firms may wish to do to avoid starting up automatic enrolment at a busy time of year for their HR and payroll departments, for instance during the end of tax year reporting rush in April. Being prepared for the new rules will lead to a more considered transition to automatic enrolment, yet repeated industry surveys have shown that a large proportion of employers are still not preparing for the new regulations. A year ago, such reserve might have been justified. The coalition government had just been formed and the workplace pension reforms hung in the balance. The fledgling government commissioned a review, which reported last October. Recommendations were made to change peripheral elements of the reforms, but the broad thrust remains. We know the answers to the questions of ‘who’, ‘when’ and ‘what’. HR practitioners and Finance Directors now need to put their heads together over the ‘how’.