What is happening in 2012?
From 2012 all employers will be required to enrol eligible staff into a pension scheme and contribute towards their retirement. Eligible staff are those aged between 22 and State Pensionable Age (SPA) who earn between £5,035 and £33,540 a year. Staff aged between 16 and 22 can also choose to opt-in to the scheme and receive an employer contribution. Agency workers, fixed term and part-time contract workers are also covered by this legislation.
Staff will be allowed to opt out of auto-enrolment, in which case employers will no longer be liable for paying employee contributions. However, those employees who do choose to opt out will be re-enrolled every three years. Employers will not have the option to opt out. For some organisations, particularly those with no existing pension scheme or low take-up rates among staff, the cost implications could be significant.
The Pensions Act will take effect from 2012 and will be gradually introduced depending on an employer’s size. All employers that do not offer a qualifying workplace pension scheme will have to enrol staff into the Government’s National Employment Savings Trust (NEST), which is being launched to provide access to a low-cost pensions’ vehicle.
Contribution levels
A minimum of 8% of an employee's qualifying earnings must be paid into a pension, which is made up of:
- 3% employer contributions;
- 5% employee contributions, of which 1% comes in the form of tax relief
It is important to note that employers may choose to pay more than the minimum of 3%, in which case the compulsory 5% employee contribution will be lower, providing that the minimum combined pension contribution is 8%.
One of the challenges that many employers face is how to balance the long-term affordability of their pension contributions with the needs of their staff. For some organisations, their current employer contribution levels may be unsustainable once the reform takes effect and all staff have to be auto-enrolled into a pension scheme. In this case of money purchase pension schemes employers have two options:
- Ring-fence existing higher contribution rates for all employees who are currently members of the scheme and offer a lower employer contribution rate for those employees who join the scheme through auto-enrolment. This ensures that those employees who were members of the organisation’s pension scheme prior to auto-enrolment are not penalised, although this may cause disharmony among any employees who receive the lower employer contribution level who may feel that they are being disadvantaged.
- The other option is to level down employer contribution levels for existing pension scheme members to a lower rate, which will be offered to all employees who join via auto-enrolment. Organisations wishing to go down this route will need to serve notice of their intention to reduce contribution levels and enter a consultation period with any affected staff. Employers will need to negotiate the proposed change in contract of employment and make a decision based on employees’ feedback to the possible changes. While reducing contribution rates may help to balance the books, employees who are affected are likely to feel they are being unfairly penalised by a reduced monies going into their pension pot.
It is also important to bear in mind that organisations that have to offer reduced contributions or the minimum 3% employer contribution rate may suffer a backlash from employees, who will then need to contribute 5% (including 1% tax relief) of their salary (or band earnings where appropriate) into their pension. This is unlikely to go down well with many employees who will see a reduction in their take-home pay. Employers will need to effectively manage staff’s perceptions around pensions as many may blame their employers for this change, regardless of the fact that it is actually a government requirement.
In contrast, some organisations may choose to offer higher contributions to staff in order to support their workforce with more effective pension planning. For some employers, offering an attractive pension scheme with a high employer pension contribution rates ensures that they stand out as an employer of choice and can support positive recruitment and retention strategies.
In the case of organisations that offer a final-salary schemes to staff, employers will need to make a decision about whether it is financially viable to auto-enrol all eligible staff into this scheme once pension reform comes around. If this is not going to be affordable with current benefits to all staff, then they may have to close the scheme to new joiners and consider an alternative pension arrangement or alternatively reduce the accrual rate in order to reduce the overall costs.
Whichever route employers choose to manage the likely cost of pension reform, a good communication strategy is essential to ensure that staff are aware of any changes and how this will affect them. It may also be sensible to work with a financial adviser to provide staff with access to financial advice and to support them with their individual retirement planning.
Managing the cost of 2012
One option that employers may wish to consider to help to manage any cost increases is the introduction of salary sacrifice. Via this method, employees elect to reduce their salary and have their sacrificed salary paid into their pension. As the employer will not have to pay National Insurance (NI) on the sacrificed salary, this contribution can be enhanced by redirecting some or all of the NI saving into the employee’s pension. See the table below to show how salary sacrifice can be used to enhance a basic rate taxpayer’s pension contributions, assuming that the employer makes a full NI rebate.
|
£1 of income for a basic rate tax payer, who uses it to make a pension contribution |
£1 salary sacrifice with employer paying pension contribution (assuming the full employer’s NI rebate is added) |
Employee Earnings | £1.00 | Nil (no NI on pension contribution) |
Employer NI | £0.13 | £1.13 |
Total cost to employer | £1.13 | Nil (£1 salary sacrifice instead) |
Employee income tax (20%) and NI (11%) | £0.31 | Nil |
Employee net monthly contribution to pension | £0.69 | Nil |
Employee’s total gross contribution to pension | £0.86 | £1.13 |
National Insurance is due to increase again in April 2011 by 1% for both employers and employees, enhancing salary sacrifice further. However, there are other considerations to bear in mind when implementing salary sacrifice and it is important to take financial advice on this.
Organisations with no current pension scheme in place may wish to start giving a proportion of annual pay increases in the form of an employer pension contribution over the next three years, for example:
- 3% pay increase awarded to staff =
- 2% increase in employee’s salary
- 1% employer pension contribution
When it comes to 2012-pension reform, my advice to employers is to analyse your existing pension arrangements and contribution levels now so that long-term affordability can be accurately assessed and any changes can be effectively communicated and managed within the organisation to minimise any negative employee reactions.
Ian Bird is principal partner, Foster Denovo.
