Pensions: The road to 2012 is paved with pitfalls

2012 will see the biggest shake-up in pensions this century with the advent of personal accounts. Harry Scott analyses what this involves and why employers may not be dancing in the streets.

If the government really wanted to ensure that people saved for their old age, it would increase national insurance (NI) contributions and direct the extra cash either into its new Personal Accounts scheme or existing pension arrangements. It hasn’t increased NI contributions because it thinks this would be viewed as increasing the tax burden, and so would be politically unacceptable.

Instead, it proposes Personal Accounts, which will be a funded industry-wide defined contribution occupational pension scheme. This will mean automatic enrolment for staff from their first day of employment. The government calls this “soft compulsion”.

Wide remit

The scheme’s remit is wide: it will apply to staff aged between 22 and state pension age, with those under 22 excluded. The government justifies this by saying that the youngest employees change jobs more frequently – if they can find one. Automatic enrolment also applies to workers, as well as employees, and in particular to agency workers. The legislation defines employees and workers collectively as “jobholders”.

Jobholders will contribute 4% of earnings between £5,035 and £33,540 a year, while employers will contribute 3% on the same band of earnings. The effect of excluding the first £5,035 of earnings is to reduce the effective rate of employer contribution on total pay. To take an easy example, the effective rate of contribution in relation to a jobholder earning £10,000 a year will be only 1.5% of gross pay.

There will also be a transitional provision whereby the employer contribution will start at 1% of earnings in the first year, moving up to 2% in the second year, and 3% from the third year onwards.

For their part, jobholders will be able to opt out of the scheme, but if they do so they will be auto-enrolled back in again every three years. The low paid are most likely to opt out, simply because they will need the money to meet their current commitments – which is ironic because the low paid are Personal Accounts’ target sector.

Employers may not like it, but it will be illegal for them to encourage jobholders to opt out or to make job offers conditional on opting out.

There will not even be an exemption for small employers. Currently, there is no duty to designate a stakeholder scheme where an employer has four employees or fewer, but there is no comparable exemption for small employers in relation to Personal Accounts. Automatic enrolment will apply as much to the corner shop as to FTSE 100 companies.

Never mind the unions

Existing company schemes, including group personal pensions, which pass a quality test will be a suitable replacement for Personal Accounts, subject to bolting on automatic enrolment.

Such a scheme, a so-called qualifying workplace pension scheme (QWPS), could be a defined benefit scheme which is contracted out on the reference scheme test or, if not contracted out, has an accrual rate of at least 1/120th of qualifying earnings. A defined contribution scheme or a personal pension scheme will be a QWPS if the employer contribution rate is at least 3% of qualifying earnings.

Some recent draft regulations have introduced the notion of a Quality QWPS. A defined benefit scheme that meets the reference scheme test will be such a scheme, as will a defined contribution scheme and a group personal pension with an employer contribution of at least 6% of qualifying earnings. The benefit to employers of providing a quality scheme will be that they will be allowed to operate a 90-day waiting period, rather than having to automatically enrol staff from their first day of employment.

These new requirements will increase costs for many employers when they come into force in 2012. An additional 3% of payroll will be a big item where an employer has only a designated stakeholder scheme but no-one has joined it, or where there has been a low take-up of the employer’s existing scheme.

Despite what the unions might wish, the cost to employers will be eliminated over time because employers will hold back pay increases so that the total cost of employing their staff, inclusive of pension contributions, will be the figure they first thought of. They are likely to make use of the transitional provisions and hold back pay rises by 1% a year for the first three years as the transitional relief for employers unwinds.

And a final thought. The combined contribution of 7% plus tax relief adding another 1% will not be nearly enough to produce decent pensions. We all know what governments are like. How long will it be before the employer contribution rate is increased to 4%, 5%, or even higher?

Harry Scott, partner, Mills & Reeve

What should HR do to prepare for Personal Accounts?

  • Establish the extent of the employer’s existing provision to assess the impact of Personal Accounts.
  • If your company has one, get an independent financial adviser to help.
  • Decide if non-joiners should be auto-enrolled into an existing scheme.
  • Or decide if Personal Accounts are more appropriate.
  • Decide whether to enroll into a quality scheme to gain flexibility of three-month waiting period.
  • A system for auto-enrolment and for dealing with opting out must be devised and tested before Personal Accounts go live in 2012.

Consider auto-enrolling staff into an occupational defined contributions scheme so that the employer contributions will fall back to the credit of the employer in relation to members who leave within two years of joining and opt for a refund of their own contributions. This would appear to be the only way of recouping some of the cost of operating auto-enrolment.

Some commentators have urged the government to permit automatic enrolment before 2012 to enable employers to test their systems before Personal Accounts go live.

The UK is getting older by the year

Projected number of people of standard pension age or older (thousands)

Year   2008 2015   2020 2030 2040   2050
 Women  7,465  7,197  6,877  7,896  8,715  8,698
 Men  4,324  5,264  5,804  6,721  7,396  7,360
 Total  11,789  12,461  12,681  14,617  16,111  16,058
 Total % of population  19%  19%  19%  21%  22%  21%

Source: Pension Policy Institute

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