Issued: August 2009
2012 Pension Reforms
The 2012 reforms bring potentially the biggest changes to UK pensions since the State Pension was introduced 100 years ago. In a recent edition of Charities Management, Stephen Nichols of The Pensions Trust introduced readers to Personal Accounts. His colleague, [Karen Parry, Head of Policy and Compliance], takes up the baton to provide further insights into the 2012 pension reforms and how they are taking shape.
If at first you don’t succeed....
The Government tried to sort out the pensions crisis in 2001 when ‘larger’ employers (5+ employees) who didn’t offer a pension scheme had to ‘designate’ a Stakeholder pension for their workforce. Employer contributions weren’t required, and it didn’t take the Government long to acknowledge that Stakeholder had flopped. In 2003 it set up a Pensions Commission to take a long, hard look at the UK pensions system. Numerous reports, White Papers and Pensions Acts later, we have State Pension reforms and the introduction, in 2012, of ‘employer duties’ and Personal Accounts.
Employer duties
The Pensions Act 2008 imposes duties on employers vis-a-vis pension provision for employees. Employers will have to auto-enrol eligible jobholders into a qualifying pension scheme (if they’re not already in one) and pay minimum contributions on their behalf.
The duties will be rolled out in stages. We’re still waiting for details – remember the reforms are three years away – but it’s likely that the largest employers will be affected first. It could be 18 months or more before all employers are covered.
Let’s dissect what the employer duties mean.
Auto-enrolment
Research indicates that where employers use auto-enrolment for their pension scheme, take-up rates in excess of 90% can be achieved. Auto-enrolment features in the employer duties in the hope that inertia will prevail and, by default, more people will start to save for their retirement.
How will it work? Employers will pass employee details to the scheme and will start deducting contributions from pay. Employees can’t be asked to complete a form, make any choices (about investment funds, for example) or provide a signature so the scheme must have a ‘default option’ for auto-enrolment purposes.
Where the employer offers a high-quality qualifying scheme, auto-enrolment may be postponed for up to 90 days. Otherwise there are no proposals for a waiting period to apply; the enrolment process should start as soon as the employer becomes subject to the duties. After this initial burst of activity auto-enrolment will be required when employees meeting the ‘eligible jobholder’ criteria start work, and when existing employees first meet the ‘eligible jobholder’ criteria. Monitoring will be required to make sure this latter category isn’t overlooked.
Employees who are auto-enrolled have the right to opt-out, but if they do you will have to auto-enrol them again every three years or so – when they can opt-out again. You will need to keep track of who opted-out and when.
The Pensions Regulator can impose penalties of up to £50,000 where it finds an employer has induced employees to opt-out.
Eligible jobholders
These are workers aged 22 to State Pension age, with ‘qualifying earnings’ – at least £5,035 in 2006/07 terms, revalued in-line with average earnings.
There will also be obligations in respect of jobholders not classed as ‘eligible’.
Employees under 22 with qualifying earnings can opt-in to their employer’s scheme. You would have to enrol them, deduct contributions and provide the employer contribution.
Workers without qualifying earnings can opt-in but employers aren’t obliged to provide a contribution (you can do this voluntarily).
Qualifying scheme
Qualifying schemes must meet ‘access’ (auto-enrolment) and ‘quality’ criteria.
Defined contribution schemes will have to satisfy a contribution test – prescribed minimum contributions will be required.
If you intend to use your existing defined benefit scheme as a qualifying scheme, it must be contracted-out of the State Second Pension using the ‘reference scheme test’, or have an accrual rate of 1/120th or better.
More information is needed on acceptable charges and contribution rates – this is expected in Autumn this year. We also need to know how the application process for ‘qualifying scheme’ status will work.
Minimum contributions
This feature applies in defined contribution (DC) schemes, and is being phased in to reduce the impact on employers’ finances and on employees’ take-home pay. The phases will last at least a year.
Phase 1 – at least 2% of the employee’s qualifying earnings (£5,035 to £33,540 in 2006/07 terms, revalued in-line with average earnings) including tax relief, with a minimum of 1% from the employer. A very low starting contribution should help to reduce the numbers opting-out.
Phase 2 – at least 5% of qualifying earnings with a minimum of 2% from the employer.
Final phase – at least 8% of qualifying earnings, including tax relief, with a minimum of 3% from the employer.
Employers can pay more than the minimum required of them, and the scheme’s definition of pensionable earnings doesn’t have to mirror ‘qualifying earnings’.
Phasing by contributions won’t apply where defined benefit (DB) schemes are used as qualifying schemes. Instead we expect employers will auto-enrol their eligible jobholders during a transitional period. We hope this will be clarified this Autumn.
Where do Personal Accounts fit in?
As soon as employer duties are imposed, Personal Accounts will be introduced as a qualifying scheme for any employer that wants to use it. It will be a low-cost, trust-based occupational DC pension scheme and its target market is workers with low to moderate earnings who don’t have access to an alternative qualifying scheme.
It’s predicted that Personal Accounts will be the only qualifying scheme offered by most ‘micro’ (up to four employees) and small (5 to 49 employees) employers.
Larger employers may already offer a scheme that will meet the ‘qualifying scheme’ criteria. These employers may not get involved with Personal Accounts at all, or may use it for new employees or for designated sections of their workforce.
The scheme is being designed and implemented by PADA, the Personal Accounts Delivery Authority. Check out their website www.padeliveryauthority.org.uk for more information.
Once the scheme is up and running it will be overseen by a trustee body and this is regarded as critical to its success. After the Equitable Life scandal, employees need the comfort of knowing that it’s somebody’s job to run Personal Accounts for their benefit and to look after their interests.
What will it cost?
It’s also critical to the success of Personal Accounts that charges are kept low, so that as much as possible of each contribution is invested to produce retirement benefits. The scheme is being designed with this low-cost requirement in mind. Most of the administration processes will use ebusiness partly to reduce the administration burden on employers but mainly to keep costs down.
The cost of running the scheme won’t be known until all the service providers (investment managers, administrators, annuity providers, etc) have been appointed, and this is quite a long way off. So far PADA has announced a short-list for the administration services contract; further procurement exercises are in the pipeline.
Features of Personal Accounts
Much of the detail is yet to be provided but various consultations and draft regulations have shed some light on how the scheme might look.
• Personal Accounts minimum contributions will be phased in; the default position will eventually be 8% of qualifying earnings, made up of 4% from the employee, 3% from the employer and 1% from HMRC representing tax relief.
• Tax relief ‘at source’ (like personal pensions) will apply.
• Members will be able to contribute to their account after leaving the employer.
• Third parties will be able to contribute on the member’s behalf (within an annual limit).
• Self employed people can opt–in.
• No refunds of contributions except on opting-out.
• Retirement between ages 55 and 75.
Protecting existing schemes
It is a policy intention that Personal Accounts should ‘complement, and not replace,’ existing workplace pension schemes. Employers may use their existing schemes as ‘qualifying schemes’ provided access and quality criteria are met.
Personal Accounts will be the UK’s ‘qualifying scheme of last resort’ and features will be built in to keep it focussed on its target market and reduce the impact on existing schemes. These will include:
• An annual limit on contributions of £3,600 (in 2005 terms, revalued in-line with average earnings).
• Very limited opportunities for transfers to and from Personal Accounts.
• No waiting period before auto-enrolment.
Regardless of policy intentions and protective features, employers have finite budgets for pension contributions. If more of your employees join a pension scheme, you may be forced to reduce contributions from their current levels. ‘Levelling down’ is a very real threat.
Next steps
The Department for Work and Pensions has consulted on auto-enrolment processes and will consult this Autumn on other aspects of the employer duties. PADA is consulting on investments for Personal Accounts and will continue with its procurement programme. At this stage, employers can identify their ‘eligible jobholders’ and forecast a worst-case scenario if they should all join a pension scheme. Otherwise, watch this space....