Reforms coming into force next year mean that, for the first time, all employers will be obliged to offer and contribute to a pension for the majority of their workers.
These reforms are being introduced in response to studies showing that the UK workforce is not saving enough for retirement to maintain the current standard of living for pensioners.
The Government’s chosen option to address this savings gap is automatic enrolment (“auto-enrolment”), where all employees will be enrolled automatically into a pension scheme, and will have to expressly opt out if they do not wish to participate.
Currently, any inertia on the part of employees results in their not participating in pension schemes which employers may offer. Auto-enrolment deliberately turns this situation on its head as workers who do nothing will be enrolled in pension scheme membership unless and until they actively opt out.
The express intention to target individuals who have not traditionally had access to work-based pension savings, means that there are very few exemptions to this employer obligation.
These reforms will be introduced in stages starting in October 2012. Therefore now is the time for employers of all sizes to prepare for their new obligations and ensure they have systems in place ready for “auto-enrolment”.
Pensions Regulator Guidance
The Pensions Regulator has issued a (somewhat daunting) set of nine detailed guidance papers. While employers will need to read these to understand the reforms fully, and consider the implications for their organisation, the FAQs below summarise the issues which are likely to be most important for employers to consider at this stage.
When do these new rules come into force?
The very largest employers must comply by October 2012, while the last tranche of the smallest employers will be given until February 2016. Size is determined by the number of employees in an employer’s PAYE scheme. Exact “staging dates” can be established using an application set up by the Pensions Regulator (www.thepensionsregulator.gov.uk/pensions-reform/detailed-guidance.aspx)
Which employees are subject to “auto-enrolment”?
The majority of workers are covered. Employees between age 22 and state pension age, earning above a current minimum yearly salary of £7,475, must be enrolled automatically into a pension scheme, and receive contributions from their employer.
Can other employees join the same scheme?
Yes. Workers who don’t meet the auto-enrolment age or earnings criteria but are between 16 and 75 are entitled to opt in voluntarily, and to receive employer contributions, provided they have annual earnings above a current £5,065 floor.
What about part-time, fixed-term or agency workers?
These workers will potentially be eligible, too. For agency workers, contracts and other arrangements will need to be analysed to determine who in fact employs them. It may be necessary for employers to take legal advice in establishing this.
Is there an exemption for very small employers?
No. The reforms are expressly intended to cast a net wide enough to cover the whole UK workforce, many of whom work for businesses with only a handful of employees. Very small employers are, however, being given the longest time to prepare for the changes.
What does auto-enrolment mean for my company?
You will have to set up systems so that employees will be enrolled automatically into your chosen arrangement, first of all on your “staging date”, and thereafter on the date that new employees join the company. If any employees choose to opt out, after having automatically enrolled, you will need to process this as well.
That’s all quite onerous. Is there anything else we’ll have to do?
Employers need to keep reviewing employee details, since changes in age and salary will mean that some staff who previously did not need to be auto-enrolled will become entitled to be enrolled as and when they first meet the age and earnings requirements.
In addition, the whole process of automatic enrolment has to be repeated every three years for any employees who have chosen to opt out. Such employees can choose to opt out again, and the employer will then need to process that request (again).
How much will employers have to contribute?
That depends on the type of scheme chosen (see below), but assuming that most employers will choose a money purchase (or defined contribution) arrangement, initially employers will have to contribute 1% of the worker’s salary, rising to 2% in 2016, and finally to 3% in October 2017. Salary for this purpose is limited to only that part of it which exceeds a current threshold of £5,715, so that an actual salary of £20,000 would effectively be reduced to £14,285 for the purpose of calculating employer contributions.
What options are there for selecting an auto-enrolment scheme?
Employers have a choice between offering employees enrolment into the centralised National Employment Savings Trust (NEST), or into a “qualifying scheme” specific to that employer (or to a group of associated employers).
Do we have to use the same scheme for all our employees?
No. As long as all eligible employees are enrolled into NEST or a “qualifying scheme”, employers can choose to operate more than one arrangement. For example, if an employer currently only offers a particular pension arrangement to certain grades of staff (and that arrangement would count as a “qualifying scheme”), it would be possible to set up a separate autoenrolment scheme just for eligible employees in other grades.
How will NEST work?
NEST is a trust arrangement which will be set up and administered centrally. NEST will invest all the contributions an employee makes (together with their respective employer contributions), using a standardised investment policy, in order to provide an individual fund built up for the employee’s retirement.
The employee will need to pay NEST an annual management charge of 0.3% of the value of his total fund, and an initial 1.8% contribution charge (to meet NEST’s set-up costs) on all contributions into his fund.
Why might employers prefer to use a “qualifying scheme”?
This option means an employer can tailor the design of a scheme towards its own circumstances and those of its employees, particularly in relation to the investment options available for the employee’s pension fund. However, an employer would need to be ready to accept the burden of administering and operating that scheme, or to pay an external provider to carry out that task.
Can we use our existing scheme as a “qualifying scheme”?
Existing arrangements can only be used if they fulfil all the criteria for a “qualifying scheme”. It is likely that many existing schemes will not, especially in terms of eligibility for entry, or in the way that they determine which elements of overall pay are pensionable. Such schemes will need to be amended to comply with the criteria before they can be used for auto-enrolment purposes
We’ve already got a stakeholder scheme. Can we use that instead?
In principle it is possible to use an existing stakeholder (or group personal pension) scheme, but again, this would have to satisfy the criteria. It is unlikely that most current stakeholder schemes would do so, since even if employer contributions are offered, the arrangements with the external scheme provider will generally require the employee to apply for membership. These arrangements will need to be changed (with the cooperation of the scheme provider) to allow for employees to be automatically enrolled.
I’ve read about final salary schemes being used for auto-enrolment. You seem to skip over this point. Why?
Final salary and other defined benefit (DB) schemes can indeed be used, provided they meet the necessary criteria. However, it is unlikely that many employers will wish to use a DB scheme as their sole arrangement for auto-enrolment, given that few employers retain a DB scheme open to new joiners. If an employer has a closed DB scheme which is still open to accrual for existing members, it may be possible to use that arrangement as a qualifying scheme for the existing members (so that there is no need to auto-enrol those employees into another scheme as well as continuing their DB accrual).
This all sounds like a significant cost to our business, in terms of money and time. What would happen if we simply didn’t comply?
The penalties for non-compliance are very stiff. The Pensions Regulator will have the power to fine an employer for every day that it fails to comply with the auto-enrolment requirements. For larger employers (with more than 500 employees), the maximum fine is set at £10,000 per day, far exceeding any previous penalties for non-compliance with the requirement to designate a stakeholder scheme.
Won’t employers try to find a way around the obligations, given the costs of complying, and the consequences of not complying?
The legislation contains measures designed to prevent avoidance, backed up by powers for the Pensions Regulator to impose significant financial penalties.
For example, the Regulator will be able to fine an employer offering “inducements” for workers to opt out of pension entitlement, or who tries to screen applicants at recruitment so that it will only take on staff who have indicated they will opt out.
The Regulator can also exercise these powers where an employer takes detrimental action (such as dismissal) against those employees who then fail to opt out.
Employers need to act now
First it is essential to check your exact staging date. This sets the deadline by when the auto-enrolment obligations apply – when the employer must “go live”.
In order to have everything in place for then, there are important decisions and preparations to make. The most important of these include:
- Will NEST or a qualifying scheme be used?
- Does an existing arrangement meet the “qualifying scheme” criteria?
- What amendments are needed if it is to qualify?
If it is necessary to amend an existing scheme, or to establish a new one, advisers and/or providers will need to be contacted early enough to undertake their work and for the employer to take any resulting steps well ahead of its staging date.
HR systems (such as payroll) will almost certainly need to be upgraded to cope with auto-enrolment, so that, for instance, changes in an employee’s salary or age are tracked and alerts are issued when an employee crosses the auto-enrolment threshold.
These questions above address some of the most important issues. However, given the complexity of the auto-enrolment provisions, we would recommend that employers review the Regulator’s detailed guidance closely against the background of any existing arrangements, and seek further assistance from their usual advisers.