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• Minimum employer contributions and auto-enrolment, if it results in increased pension scheme take-up, could lead to a rise in pension costs for employers when the 2012 reforms come into effect.

• There are a number of actions employers could consider to manage these increased costs.

• These include salary sacrifice around pension contributions, absorbing the cost into other areas of the business, and reducing employer contributions for new staff.

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Employers do not have long to prepare for the extra pension costs arising from the 2012 reforms, says Jennifer Paterson

With the 2012 pension reforms fast approaching, speculation is rife about how much auto-enrolment and compulsory contributions will increase employers' costs. The Department for Work and Pensions estimates that increased membership, higher employer contributions and administrative overheads could add a total of £3.5 billion a year to UK employers' pension bills.

Charles Counsell, interim head of employer compliance at The Pensions Regulator, says: "Auto-enrolment and the phasing in of contributions will be staged over four years. This will allow employers of all sizes to manage their costs."

Employers with more than 120,000 staff will begin auto-enrolment in October 2012, with other organisations then phased in according to their size. Those with between 50 and 89 employees will be brought in by 1 July 2014, and the very smallest employers will have to comply by various dates between 1 March 2014 and 1 February 2016.

The phasing-in of compulsory contributions will begin in October 2012, when minimum levels will be set at 1% for both employers and staff. The second phase, from October 2016 to September 2017, will see these rise to 2% for employers and 3% for staff; and the third phase, from October 2017, will reach the maximum of 3% and 5% respectively.

Richard Wilson, senior policy adviser at the National Association of Pension Funds (NAPF), says: "From 2017, it will be 3% employer contributions, but that will slowly increase from 1% in 2012. This will help employers manage wage increases to offset some of that cost."

Scheme administration may also add to costs. Paul Macro, senior consultant at Towers Watson, says: "One solution is to move to a contract-based pension arrangement where all the costs are lumped together in an annual management charge."

Absorb costs into other areas

The most popular way employers plan to manage increased costs is to absorb them into other areas of the business, according to the Employee Benefits/Alexander Forbes Benefits Research 2011, published in May, which found 42% intend to do so. Other plans include: introducing salary sacrifice (23%), offering statutory minimum contributions to some staff (13%), introducing the national employment savings trust (Nest) for some groups of staff (11%), cutting other non-pension benefits (11%), and reducing employer pension contributions for new staff (10%).

Tom McPhail, head of pensions research at Hargreaves Lansdown, says: "We will see more use of salary sacrifice as a way round the problem. It by no means entirely offsets the cost, but it helps."

Another option is to reduce employer pension contributions for new staff. The NAPF's Wilson says: "This means having lower contributions for new members or putting them in some sort of nursery scheme for a few years before moving to the more generous existing scheme, or perhaps auto-enrolling staff at a lower level than the maximum contributions available at present."

Although there is no way for employers to avoid the extra costs of the 2012 reforms if they do not already comply with minimum compulsory contribution levels and have 100% take-up of their scheme, there are ways they can manage them. Employers should also step up communication with staff around the reforms, says McPhail. "They should make sure employees are aware of what is being paid in and that they appreciate what the employer is doing for them."

Read more on the 2012 pension reforms