Andrew Tully Senior Pensions Policy Manager Standard Life

There have been an increasing number of pension acts over the last few years but the 2008 variety promises to live long in the memory of most employers. Much of the coverage of this piece of legislation has focused on personal account, the government-sponsored pension scheme which will be introduced in 2012. But this is only a sideshow to the main event. The pensioner’s act 2008 introduces compulsory pension provision which means, from 2012, employers will need to enrol most of their staff in a pension scheme automatically and pay a contribution of 3% for those who remain members.

 

For employers who don’t currently offer a pension scheme, the requirement to pay 3% of band earnings for those who don’t opt out will increase business costs. This may be an extra 2% or 2.5% of payroll, given that the first £5,035 of earnings is ignored and depending on how many employees opt out.

Most employers who currently offer pension schemes will also be affected. Many schemes in the UK operate on an opt-in basis where employees need to choose to join their employer’s pension scheme. The switch to automatic enrolment, where people are members unless they actively decide not to be, is likely to see an average take-up increase from around 55% to nearer 80%. And the requirement for a contribution of 8% of band earnings, with at least 3% being paid by the employer, may be higher than in many current schemes. Again an increase in employer costs is likely.

All schemes will also need a default investment fund as auto-enrolment will mean some people become members without their active involvement. Some pensions, currently offer default funds but others will need to ensure a suitable default is put in place by 2012.

Employer actions
So what actions are employers likely to take in response to theses changes?
Some employers may reduce contributions where they currently pay above 3%. Bearing in mind more staff will join to auto-enrolment; this may keep overall pension costs broadly similar. However, this could be problematic as it may involve changes to contracts of employment and will be clearly noticed by employees and, especially, unions.

Closing the current scheme altogether may be considered, but an employer still needs to pay at least 3% to some type of pension scheme approach, offering a good quality scheme for more senior staff who they want to reward and retain, with lower paid employees enrolled in personal accounts.

Learning lessons from overseas gives clues to other alternatives. The introduction of compulsory pensions in Australia has led, over time, to lower salaries. By planning early and awarding salary increases each year up to 2012 which are lower than originally envisaged, employers could save enough to offset the cost of higher pension contributions. 

Other employers may mimic personal accounts and pay contributions based on a band of earnings.

Threats and opportunities
The pension reform changes bring both a threat and an opportunity to advisers working in the corporate market. Its clear that auto-enrolment along with a compulsory 3% employer contribution will shake up the current market. Employers need help working out strategies to cope with increasing pension costs. Discussing options over the next year or so allows more time to plan these alternative approaches.

But the changes also bring huge opportunities for advisers. The introduction of auto-enrolment will increase membership of these existing schemes. Substantially in some cases. Employers who don’t have a pension scheme, or don’t have schemes covering their entire workforce, need to introduce provision. And some will opt for private schemes rather than personal accounts.

This is an important act for advisers to be familiar with, even though many of its provisions don’t take effect for another three year. The impact of pension’s reform will vary enormously, so whatever the employer’s circumstances, the need for financial advice has never been greater.