Debi O’Donovan, editorial director, Employee Benefits: Employers need to budget for pension contributions based on total pay in run up to 2012

Debi O’Donovan, editorial director, Employee Benefits: At the recent Employee Benefits Summit, attended by 50 senior benefits managers from some of the UK’s largest organisations, it became clear that the vast majority had no idea that pensions contributions to the new Personal Accounts will be based on total, not basic, pay.
They paled visibly as it dawned on those with large numbers of staff on variable pay, that they needed to have urgent conversations with their finance bosses in order to revise pensions budgets to meet this extra cost from 2012.
To date ‘qualifying earnings’, as defined for personal accounts, has not attracted much attention. Many employers (and no doubt, some employees) are in for a shock when it becomes clear that pensions contributions will be based on total pay (between earnings of £5,035 and £33,540) and will include bonuses, allowances, overtime, commissions and other overtime pay.
Originally, this definition of qualifying earnings was also going to apply to existing schemes if employers want to be exempt from offering PAs. But after strong lobbying by industry bodies, on 22 July the minister for pension reform Mike O’Brien announced an exemption which means that employers will be able to use existing arrangements to calculate qualifying earnings provided the result is an “as good, or a better pension outcome” as that from PAs.
But back to contribution specifically for PAs. Using total pay will also increase administration for employers and payroll staff because the pension contribution for each employee on variable pay is likely to change with each payroll run.
Employees earning variable pay may themselves not be too happy about being asked to pay higher contributions. Certainly a quick (and very unscientific) strawpoll around our own sales teams indicate that basing pension contributions on total pay is going to be very unpopular – which might influence their decision on whether to opt out of pensions savings altogether.
Personally I support the notion of basing pension contributions on total pay. A key aim of this legislation is to ensure that a median-earning employee is able to retire on 45% of those median earnings. This will not be achieved if those who earn a significant portion of their annual pay through variable pay are only saving for a pension based on their basic pay. They will certainly not save enough to retire to lifestyle to which they have become accustomed.
And a second reason not to base contributions only on basic pay is that the more unscrupulous employers may try to avoid paying contributions altogether by reclassifying their employees’ earnings; using a low basic and high variable pay strategy.