Industry Intelligence

Introduction - Automatic Enrolment

The Department of Work and Pensions estimates that around seven million people are not saving enough to achieve a sufficient income in retirement.

To address this, the Government is putting the onus on employers to encourage more people to save by introducing legislation from 1st October 2012 that will require employers to automatically enrol all eligible employees into a qualifying pension scheme to which both they and the employee must contribute. This could be an existing company pension scheme, if it meets certain criteria, or the National Employment Savings Trust (‘NEST’), a low cost pension scheme that has been set up by the Government.

Auto-enrolment will apply to all employers and is the biggest pension issue that employers are likely to face over the next few years. You can prepare now by gaining a thorough understanding of the changes and their potential impact on your company.

The following is a summary of the main features of the new legislation and what they mean to you.

Automatic enrolment and compulsory contributions

Employees will have to be automatically enrolled if:

• They are not already an active member of a qualifying scheme; and
• They are aged between 22 years and state pension age; and
• They have earnings equal to or greater than the personal allowance (£7,475 from 2011/12).

Employees aged between 16 and 21, or over state pension age but under 75, can ask to be enrolled and you will have to make contributions for them.

Employers will be able to operate a waiting period of up to 3 months before automatically enrolling employees. This will assist employers that have a high turnover of staff, especially those that employee seasonal workers.  If an employee wishes to opt-in during the waiting period however, they will be entitled to do so and benefit from employer contributions.

The minimum contribution set by the Government is 8% of qualifying earnings, broken down as follows:

Qualifying earnings are PAYE earnings between the lower threshold for NI contributions (£5,715 for 2010/11) and an upper limit (£38,185 for 2010/11) and include salary, bonus, commission, overtime, maternity pay, paternity pay, adoption pay and anything else that is subsequently specified under the regulations.

It is possible for employers to pay more and employees to pay less than the amounts shown above, as long as the total contribution is at least the minimum.

The ‘phasing-in’ period

Auto-enrolment is to be introduced in stages between October 2012 and October 2016, starting with the largest employers.

Employers will be segmented based on their size, assessed by using PAYE records from HMRC. Employers with more than one PAYE scheme will have to implement auto-enrolment when the first PAYE scheme is obliged to offer auto enrolment.

To give employers the opportunity to adjust gradually to the cost of the reforms, compulsory contributions can be phased in for defined contribution schemes as the following table illustrates:

Qualifying company schemes

Employers can use their existing company pension scheme to auto-enrol employees provided that it meets the following criteria:

• Employees are auto-enrolled within 90 days of joining the company;
• It has a default investment fund;
• Contributions paid meet the minimum contribution rate of 8% of qualifying earnings.

Many schemes however, base contributions on salary definitions that exclude overtime, bonuses etc. To simplify matters, employers will be able to certify that contributions meet the required minimum by choosing one of the following three methods:

• A minimum of 9% of pensionable pay (including a minimum 4% employer contribution); or
• A minimum of 8% of pensionable pay (including a minimum 3% employer contribution) provided that pensionable pay amounts to at least 85% of total pay; or
• A minimum of 7% of pensionable pay (including a minimum 3% employer), provided that pensionable pay equals total pay.

The qualifying criteria are intended to allow employers to easily compare and choose the form of pension provision that best suits their company.

National Employment Savings Trust (NEST)

From their staging date, employers that do not already operate a qualifying company scheme must either set one up or enrol eligible employees into the NEST scheme.

NEST is a simple, low-cost pension scheme primarily aimed at lower earners who don’t have access to a good company pension scheme.  It has a number of features that will ensure it remains suitable for these individuals:

• A competitive charging structure made up of an annual management charge of 0.3% and a contribution charge of 1.8% to meet the cost of establishing the scheme. The intention is for the contribution charge to be removed once the set up costs have been covered.
• A limited choice of investment funds and a default fund for members that do not wish to make their own fund choice.
• An annual contribution limit of £4,271 in today’s terms. This limit will be adjusted annually in line with earnings growth. It has been recommended that this limit be removed in 2017.

Whilst NEST might appear to be a reasonable alternative to running a company pension scheme, it is unlikely to have as much appeal to moderate or higher earners due to the contributions cap, or to employees looking for a greater degree of investment choice. Retaining their own company pension scheme could be a more effective benefit and retention tool for employers.

Salary Exchange

The increase in national insurance contributions (‘NIC’) in recent years has led to more employers offering salary exchange as a tax-efficient method of boosting pension contributions.  

How salary exchange works

Salary exchange is an agreement between an employee and their employer whereby the employee agrees to exchange part of their future gross salary or bonus in return for a non-cash benefit such as an employer pension contribution. As part of the salary is being ‘exchanged’ rather than paid, neither the employee nor employer pay national insurance contributions (‘NIC’) on the exchanged amount.  

The employer can decide to keep all of the NIC saving, or pass on some or all of it to the employees in the form of increased pension contributions. Sharing the saving with employees provides a greater incentive for them to utilise salary exchange and the employer can still retain part of it to assist with the financing of employee benefits. Salary exchange can also be set up on an ‘opt-out basis’ whereby employees are automatically entered into salary exchange unless they complete a form to opt-out.

This is a legitimate form of tax planning accepted by HMRC, provided it is properly documented and carried out in accordance with HMRC guidelines. However, there are some disadvantages

However, although salary exchange is an attractive proposition, it is not suitable for everyone and there are several factors that should be considered before an arrangement is entered into:

Support from Cavanagh Corporate

Cavanagh Corporate has assisted many clients in operating salary exchange and is able to offer assistance with implementing and promoting a new arrangement. The services we can offer are as follows:

• Calculation of NI saving – through our salary exchange calculator, we can provide a detailed breakdown per employee of the employee and employer NI saving;
• Guidance on setting up the arrangement – the exchange can be set up in a number of ways and we can provide guidance to the employer on which option best meets its objective;
• Communication – clear communication is essential if a salary exchange arrangement is to be successful. We can draft member announcements, packs and deliver on-site presentations as required. We can also provide the exchange letters to be signed by the employees.
• Notification to HMRC – we can assist employers in obtaining confirmation from their local tax office that they are applying the correct tax treatment after a salary exchange arrangement has been implemented.

The Retail Distribution Review

The Retail Distribution Review (‘RDR’) was launched by the Financial Services Authority (‘FSA’) in 2006 to look at how retail investments and, latterly, corporate pensions, were distributed in the UK. Its key objectives were to ensure that:

• Independent advice is truly independent and reflects investor’s needs;
• People can clearly understand the services they are being offered;
• Recommendations made by advisers are not influenced by product providers;
• Investors know up front how much advice is going to cost and how they will have to pay for it;
• All investment advisers will be qualified to a new higher level.

The final rules, set to be implemented on 31st December 2012, highlight a number of areas of reform for group pension arrangements.

Removal of commission for new schemes

The FSA believes that commission creates a provider bias and therefore has removed the ability for providers to pay commission on new schemes set up after 31st December 2012.

Commission will be replaced by ‘Consultancy Charging’ which will apply when an adviser provides services in relation to a group pension arrangement. This encompasses giving advice to the employer on the operation of the scheme or giving advice to the employee about the benefits of the scheme. The level of charge will be agreed between the adviser and employer and can be in the form of a fee paid by the employer or can be deducted from the contributions paid to a member’s plan. This is regardless of whether the individual member receives advice or not.

Importantly, payments to advisers must coincide with charges deducted from members’ policies which will result in these being paid in instalments over time. There will no longer be any scope for advisers to receive an up-front payment to cover the cost of carrying out the initial work, (termed ‘factoring’) particularly in setting up new arrangements. If an employer is unwilling or unable to pay an up-front fee to cover these costs, the level of charges that may need to be deducted from the members’ plans could result in very little or even no contributions being allocated in the early months.

The new rules apply to both contract-based and trust-based schemes, creating a level playing field between the two.

Existing schemes

Schemes set up before the end of 2012 on a commission basis can continue to pay commission after 2012, including on new entrants and contribution increases. Any other approach would have led to the huge complexity of having to operate different charging bases for pre and post-RDR members.

What this means for employers

Whilst there is an argument that the removal of commission does drive out the potential for any provider bias, it is questionable whether reforms that simply drive charges from being applied over the lifetime of the contract to an initial charge work in the best interest of the members.

The removal of factoring could significantly impact on the level of advice that will be provided to members in future unless the employer is willing to pay a fee for these services.  

Also, whilst there are no regulatory requirements to remove commission on existing arrangements, there is always a concern that some providers may use the implementation of RDR as an excuse to renegotiate their current obligations.

In light of the above, it is critical for employers to ensure that their existing pension arrangement is set up on a basis that will be sustainable beyond 2012, allowing for both RDR and auto-enrolment.

Contact Cavanagh Corporate

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