Pension reforms: Clearing the confusion

If you read nothing else, read this . . .

• Many employers are unprepared for the reforms, including auto-enrolment. Some do not know when they have to comply or how much it is going to cost them.

• There is still confusion over matters such as the definition of qualifying earnings.

• There is concern over how to manage transient workers. There will be a three-month waiting period before employers have to auto-enrol new joiners.

• Employers are unclear about which aspects are dealt with by Nest Corporation, The Pensions Regulator and the DWP.

Case study: Metal Assemblies steels workers for changeover

Metal Assemblies, a manufacturer of pressed steel components and assemblies for the automotive industry, employs about 120 people and has traditionally operated a stakeholder pension scheme into which it contributed 3% of all employee earnings.

In September, the business moved all its existing staff over to the national employment savings trust (Nest) on the same terms, ahead of auto-enrolment in 2014.

Company chairman Stuart Fell says: “One of the big advantages of Nest is that it allows the government to force the financial services industry to offer pensions that are efficient and affordable.

“In our old scheme, members paid fees of about 1% a year. That does not sound a lot, but in a market where investment is achieving only 2% or 3% return, it is taking away a third or half of the return. With Nest, it is targeting fees of something like 0.5%.”

Fell’s only concern about the reforms is that employers have to auto-enrol all staff, even if an employee has expressed a desire to opt out. “You could have a pay period where payments are made and then they want them back,” he says. “It has to be seen how much of a muddle that becomes.”

Doubts still surround some aspects of the pension reforms, and employers need to get up to speed on what they are required to do, says Nick Martindale

When the first organisations automatically enrol their employees into qualifying workplace pension schemes or the national employment savings trust (Nest) from 2012, it will mark the beginning of the end of a long process that originated under the former Labour government in 2006.

Despite the length of time employers have had to get to grips with the introduction of the reforms, many remain under-prepared. In many cases, this may be due to a lack of clarity, and confusion, that still surrounds some aspects of the reforms.

Hyman’s Robertson’s research Auto-enrolment: time for action, published in June 2011, suggests that many of the UK’s largest employers, which will have to comply with the legislation first, do not know when they need to be ready and have underestimated the amount of time they need to prepare. For example, of the report’s 76 respondents, 39% believe it will take less than six months to prepare, instead of the recommended 18 months.

Darren Laverty, partner at benefits and pensions adviser Secondsight, says: “The vast majority [of unprepared employers I meet] are unaware of the cost implications they face and the amount of administration the changes will put on their business.”

There is also confusion over which aspects of the legislation are dealt with by the various authorities: Nest Corporation, The Pensions Regulator and the Department for Work and Pensions (DWP), says Laverty. “The volume of jargon that surrounds the pension changes is causing significant confusion.”

Speculation that the government is considering a delay to auto-enrolment is also the cause of some confusion. However, the DWP has said the coalition remains committed to the reforms’ existing timetable.

Lack of preparation

Further confusion and subsequent lack of preparation results from the continuing tinkering with the Pensions Bill, which is currently being submitted for Royal Assent following a consultation period, which resulted in a number of changes.

Staging dates for the smallest employers have been pushed back to start from April 2014. The Pensions Regulator has announced further changes to staging dates, which will affect smaller employers sharing pay-as-you-earn (PAYE) schemes with larger employers.

An extension of up to 23 months has been granted to employers with fewer than 10 employees that share PAYE schemes with organisations with more than 239 staff. This means no employer falling into this category should face a staging date earlier than January 2015. Previously, these schemes would have had to comply with the staging date allocated to the larger employer.

Margaret Snowdon, chair of the Pensions Administration Standards Authority (PASA), says: “The problem is that the employment world does not neatly fit into large and small organisations. Rules can be a bit of a blunt instrument. But the DWP has recognised this issue, so it should be fixed when the Pensions Bill is enacted.”

Another issue that has been causing confusion concerns the government’s proposed system to define employees’ pensionable earnings, upon which contributions will be based. Its focus on qualifying earnings is at odds with the more conventional measure of basic pay, which is used more regularly by employers. This concern has been partially addressed in the most recent guidance on the certification test (see below).

Catherine Cunningham, policy adviser at the National Association of Pension Funds (NAPF), says: “Schemes which use definitions of pensionable pay that are different from the DWP’s definition of qualifying earnings will be able to use the new system of certification in order to ensure that they meet the auto-enrolment quality requirements.”

This is particularly important because schemes that use basic pay as their definition of pensionable pay will, typically, calculate higher contributions than if they used the qualifying earnings measure. However, clarification is needed on variable pay.

Regulator’s final guidance

“It is not clear how employees with variable pay will be treated, or what salary sacrifice means under auto-enrolment,” says Cunningham. “Hopefully, these tricky areas will be covered in The Pensions Regulator’s final guidance.”

Jonathan Reynolds, director of financial management at RSM Tenon, adds: “All earnings must be included: basic pay, commission, overtime, bonuses, maternity and paternity pay. This will set the minimum contribution levels. Whatever an employer’s solution, it must be able to ensure that it meets the minimum requirements.”

Another hot topic is how organisations, particularly those in the hospitality or retail sectors, should manage transient workers. Employers will be given a three-month waiting period before auto-enrolling new joiners. Cunningham says: “This means employers will no longer be forced to enrol employees who stay for very short periods or who are likely to opt out anyway, avoiding the substantial cost of setting up scheme membership and refunding contributions. Employees are still protected because they can choose to join the scheme during the waiting period.”

Beyond this, employers will have to enrol staff as originally envisaged. Tim Middleton, technical consultant at the Pensions Management Institute, says: “This will see a proliferation of small pension pots, which will be uneconomic for providers to manage.”

There are signs some organisations are already preparing for the introduction of auto-enrolment. Marks and Spencer, for instance, intends to auto-enrol its workforce in August 2012 to avoid the busy Christmas period, and has already switched its existing scheme to a defined contribution master trust run by Legal and General.

Ready for new regime

Informa, too, is already getting ready for the new regime, despite not having to auto-enrol its staff until July 2013.Thomas Humphris, head office HR and UK reward director, says: “Our business has historically grown through acquisition, so we have to be mindful when looking at that staging date. We could easily tip over a point by acquiring another business. That is something many other employers will have to be aware of.”

But for organisations not so advanced in their preparations, the message from the pensions industry is to get up to speed on what will be required, and when. The Pensions Regulator’s website is a good place to start, and trustees should be talking to consultants or providers ahead of further clarification of the regulations once the Pensions Bill has been passed by parliament.

Simon Butler, proposition and policy manager at Friends Life Corporate Benefits, says employers should be sure to ask the right questions when gathering information on which to base their decisions about how to respond to the onset of employer duties. These include confirming the meaning of employer duties; whether their existing arrangements (if any) are qualifying under the law; what options are available to them should they want to add a scheme to cover the requirements of auto-enrolment; and seeking clarification of the cost implications for their business.

David Yeandle, council member and finance committee chairman at the Pensions Policy Institute and a member of the Nest Corporation employer panel, says: “The communications exercise that will be done by The Pensions Regulator, DWP and Nest will be critical. Once the regulations are finalised towards the end of this year or the early part of next, we will see a growing amount of communication to employers, staff and intermediaries about what this means and how it is going to operate. The next six months will see the start of a substantial communications exercise and that will be necessary, particularly for smaller employers.”†

What employers should be doing

1. Know when they need to act. Employers can find out their provisional staging date here. This is based on the number of people in the employer’s largest pay-as-you-earn (PAYE) scheme.

2 Start the planning process. In advance of their staging date, employers should identify the staff members they need to enrol automatically. They should also review existing pension provision with their pension provider or trustees to establish whether existing arrangements need to be changed.

3 Brief key management personnel. The new duties will affect a number of areas, including payroll, HR, finance and IT, so efficient internal communications are crucial when planning for the reforms.

4 Mobilise an implementation team. Employers should establish who will be responsible for auto-enrolment within their organisation, and ensure that they have an understanding of the legal requirements and timeframes, as well as the likely impact on systems and processes.

5 Communicate the changes to all employees. Staff will need to know how the changes affect them, when they will occur and what to expect next from their employer.

Source: The Pensions Regulator

The new certification test

The certification test requires a scheme, from £1 of earnings, to satisfy at least one of the following three tiers for all of the relevant jobholders by requiring:

• Tier 1 At least a 9% contribution of the jobholder’s pensionable earnings (inclusive of a 4% employer contribution).

• Tier 2 At least an 8% contribution of the jobholder’s pensionable earnings (inclusive of a 3% employer contribution), provided that the total pensionable earnings of all relevant jobholders to whom this tier applies in aggregate constitutes at least 85% of their total earnings.

• Tier 3 At least a 7% contribution of the jobholder’s total earnings (inclusive of a 3% employer contribution). That is, all earnings must be pensionable.

Different groups of jobholders can fit into one or more of these tiers.

Source: DWP report Guidance on certifying money purchase pension schemes and the money purchase element of certain hybrid pension schemes

Read more about the 2012 pension reforms