If you read nothing else, read this . . .
- Auto-enrolment could lead to higher pension and payroll costs for employers, unless they have plans in place now to manage costs.
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Only 15% of employees are expected to opt out of pension schemes after being auto-enrolled, so employers must plan to meet extra costs, says Nicola Sullivan
Now that most of the details of the 2012 pension reforms have been nailed down, employers can get down to the business of working out how big a dent all this is going to make in their budgets, and how they will manage these costs.
This is particularly important for small businesses, and other organisations that do not currently contribute to a workplace pension or have little take-up for their existing scheme.
A number of factors will affect costs. For example, an organisation's annual staff turnover will be just one factor in calculating the cost of complying with the reforms, because this will dictate the level of administration needed and the size of scheme records that must be kept.
Compulsory contributions in play
The compulsory contributions that will be coming into play, in stages, alongside auto-enrolment are the main cost to budget.
According to the review Making auto-enrolment work, published by the Department of Work and Pensions in October, the government expects just 15% of employees to opt out once they have been automatically enrolled into a pension scheme. This will come as sobering news to any employers that are banking on the idea that large numbers of their employees might choose to opt out. James Biggs, senior corporate pension consultant at Lorica, says: "Behaviours in the UK going forward mean that most new employees joining new organisations will not opt out."
The most drastic way in which employers might seek to reduce the cost of auto-enrolment is to level down their contributions to meet the minimum requirements. However, Biggs says he expects few employers to do this.
He thinks employers are more likely to reduce costs by operating a two-tier pension scheme, auto-enroling employees into the national employment savings trust (Nest) or a defined contribution (DC) scheme with equivalent (that is, 8%) contributions. Meanwhile, an existing, perhaps more generous, pension scheme would be retained for current members. Alternatively, Nest or a pension with the minimum contributions might be offered to lower-paid staff - the target market for the 2012 reforms.
"When forced to enrol people, most organisations are thinking they will open a separate section of their pension scheme with the Nest auto-enrolment [contribution levels] rather than the levels paid on an existing scheme. This means there will be a two-tier pension structure," says Biggs. "Going forward, it would be at the [employer's] discretion which tier of entry it would offer for all new employees."
Of course, any employers considering such an arrangement would have to ensure they were not in breach of discrimination laws.
Steer clear of levelling down
But organisations that want to stand out as employers of choice will steer clear of levelling down, even if this puts them under cost pressure. David Bird, a senior consultant at Towers Watson, says: "As every employer has to offer a pension, it is no longer a voluntary act to have a good pension scheme, which changes the emphasis.
"So employers that want to differentiate their reward offering by way of pensions are going to carry on doing so. But they will have to make more effort to make sure their employees understand the value of it."
Another way employers might manage costs is to reduce future pay rises, siphoning a proportion of any increase into the pension scheme. Emma Douglas head of DC sales at BlackRock, says: "Employers might reduce contribution levels overall, but this is an option we hope will not be taken. Some might not increase salaries as much as they were going to because they have to pay extra pension contributions. All these things are not great news, but in reality no company has got spare money sitting around."
Employers are also likely to take a closer look at saving costs on deferred members of their existing pension scheme who no longer work for the organisation. Although they will not be able to go back on their original promise of pension benefits, they might consider getting deferred members to contribute more to admin costs, which can be more than £30 a year for each individual.
Bird says: "With many defined contribution schemes at the moment, members pay the annual management charge and the company pays the administration fee. But there might be some moves to get employees to pay for some of the administration charges as well, particularly when they leave."
As it stands, auto-enrolment has different implications for trust-based and contract-based schemes. For example, trust-based schemes normally operate with a two-year vesting period, which means that if a member leaves within this time, they are entitled to a refund of the current value of contributions, minus the tax breaks. The employer is also entitled to a refund of its payments into the scheme.
Contract-based schemes
Douglas says: "With contract-based schemes, employees can transfer [savings] somewhere else, but they cannot actually get their money back. In trust-based schemes, there is normally a two-year vesting period. If a member leaves within two years, they can take back their contributions. The employer takes back its contributions as well.
"If there is a high turnover, a lot of those employees who leave within two years are actually going to say 'I want the money - forget about leaving this as a preserved pension'. Equally, the employer will say 'I want the money, thank you very much' and that could pay for quite a lot of the extra cost involved in the 2012 regulations."
However, the review indicates that the government is looking at ways to create a more level playing field between trust-based and contract-based schemes.
Although Nest is one of the most cost-effective options for employers with no existing pension scheme, some advisers believe many employers are reluctant to use it and would prefer to set up a group personal pension with the same contributions.
Lorica's Biggs says: "There is genuine anxiety about Nest's ability to deliver all the things that the proven life and group pensions market will deliver. It is the robustness of the support that employers might need and the online technology that is, as yet, to be proved in a live environment. It is the fund range and the very fact that the government will be running it or having a heavy hand on the tiller. [The government] has not necessarily covered themselves in glory with electronic-based projects in previous decades."
So although the pension reforms will cost employers more, there are way to manage the costs over the coming years and still ensure staff get good-quality pensions.
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Breakdown of costs
- Total additional pension contributions across all 1,230,000 employers in Great Britain over the implementation period are estimated at £17.1 billion.
Source: Making auto-enrolment work, Department of Work and Pensions, October 2010
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Cost to small organisations
The Federation of Small Businesses (FSB) estimates the administrative costs to small and medium-sized enterprises (SMEs) of auto-enrolling their employees will amount to £2,550 per employer.
The Department of Work and Pensions had said that SMEs, with an average of four employees earning about £25,000 a year, will pay only £46 a year per person in administration costs.
Mike Cherry, FSB policy chairman, says: "It is vital that everyone is able to save for their future, but the automatic enrolment scheme is going to cost the smallest businesses dear. The true administrative costs are unknown and could be extortionate."