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SMEs forced to freeze salaries or take pension contributions from profit to fund auto-enrolment

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More than a third of small businesses will be forced to freeze salaries to pay pension contributions and afford the cost of auto-enrolment, when it comes into effect next year, according to the Institute of Directors (IoD).

When employers were asked how they would make the 3% contribution of employees' salaries, 34% they would have to pay for it from profits.

More than half (57%) of employers said the added time burden derived from auto-enrolment will be very high or high, versus 10% who thought it would be very low or low.

The survey also found 43% (95% of SMEs) do not have any pension arrangements for employees into which the employer contributes, so these firms will be affected directly by the new auto-enrolment obligations.

It is these firms that will have to implement and finance auto-enrolment. This is particularly concerning since these businesses lack the specialist human resource functions that big firms can afford and are struggling to cope with their existing employment law obligations already.

Employees' salaries could be hit by auto-enrolment. When employers were asked how they would make the 3% contribution of employees' salaries some said they would look at employee salaries rather than take the cost out of profits - specifically, 33% said they would freeze salaries and 9% would decrease salaries.

Many employers are still unaware that they will be required to set up and fund employee pensions. One out of five of employers are not aware that there will be legislation, commencing in 2012, that requires them by law to enrol employees who earn over the income tax personal allowance, into a pension scheme and to make contributions on their behalf.

There is great uncertainty about what proportion of employees will exercise their right to 'opt out' of auto-enrolment with 16% of employers thought that none of their employees would opt out. But 24% of employers said that they thought the opt-out rate could be as high as 51% or more. Tellingly, 29% said that they had no view on what the opt-out rate would be. An inability to afford the contributions was cited by employers (48%) as the biggest single explanation for why employees might opt out. Employees will have to pay in 4% of band earnings.

Miles Templeman, director-general of the IoD, said: The Government shouldn't underestimate the cost burden that auto-enrolment is going to place on small firms. Bigger businesses will mostly have pension arrangements for employees set up. Of course we need to improve retirement provision in the UK, but yet again it's the small entrepreneur who is hit.

"Since the Government isn't prepared to change course on what's essentially a major piece of employment regulation, it needs to compensate for this burden with an equally significant deregulation elsewhere. Phasing in auto-enrolment buys us some time, but the private sector can't be expected to bounce back and create new jobs in the longer run if the Government keeps dropping new cost burdens on firms."