Pensions Reform 2012

Unless you have been living under a rock for the last few years, you will be aware that advisers, technicians and providers have been trying hard to understand the requirements of auto-enrolment, which arrives in October this year.

Quite simply, we are living longer and saving less and this combination of inertia with regards to planning for retirement, combined with the closure of so many occupational schemes, has lead to both the present and previous Government to tackle this issue.

Starting with the large 'macro' employers, new rules will mean that all employers will have to auto-enroll eligible jobholders into either NEST (National Employment Savings Trust – the new Government pension scheme) or choose an alternative pension scheme which ticks certain boxes, so is deemed as 'qualifying'. Qualifying schemes will allow employers to certify that they already have a suitable plan and comply with the auto-enrolment regulations so they can ignore NEST.

Auto-enrolment and the minimum contribution rates will be staged over several years, (the exact timing is dictated by head count of the employer).

  • Step 1 – determine whether the company is affected.
  • Step 2 – determine the category of employee
  • Step 3 – determine what type of scheme will be most appropriate
  • Step 4 – comply with the auto-enrolment regulations

All eligible jobholders must be auto-enrolled, but will be able to opt out should they so choose. Those individuals who do opt out must be auto-enrolled again 3 years later.

auto-enrolment flow chart

A worker is defined as any individual who:

  • works under a contract of employment (an employee), or
  • has a contract to perform work or services personally (i.e. they cannot send a substitute or sub-contract the work) and is not undertaking the work as part of their own business.

The contract does not have to be in writing and can be verbal or just implied (as such, this definition could include agency and casual workers, carers and nannies for example).

NEST Contribution Rates – Qualifying Earnings

Under NEST, employers will need to contribute 3% on a band of earnings for eligible jobholders – between £5,564 (the lower qualifying earnings band limit for 2012/2013) and £42,475 (upper earnings limit for 2012/2013). This will be supplemented by the jobholder's own contribution and around 1% in the form of tax relief. Overall contributions will total at least 8% for this type of scheme. NEST will carry an annual management charge of 0.3% per annum.

Using other types of scheme other than NEST

To comply with the auto-enrolment criteria a scheme must meet the qualifying criteria (see below). There can be no barriers to prevent the employer from auto-enrolling, opting in or re-enrolling jobholders. In addition, schemes cannot promote the opting out of a scheme or offer any form of enticement to do so.

To comply with the qualifying criteria any other scheme will need to be an occupational or grouped personal pension scheme, will need to be tax registered and will need to satisfy minimum requirements depending what type of scheme it is. We give a summary below.

Group Personal Pension / Group Stakeholder Schemes

  • There must be an agreement in place between the employer and the pension scheme provider under which:
  • The employer must make contributions in respect of the jobholder
  • Employer contributions must be at least 3% of jobholder's qualifying earnings
  • If the employer does not pay the full 8% contribution then there must be an agreement in place between the jobholder and the pension scheme provider under which the jobholder contributes the difference between 8% of qualifying earnings and the employer contribution
  • There must be a direct pay arrangement between the employer and the jobholder.

Occupational Money Purchase Scheme

  • The employer must make contributions in respect of the jobholder
  • A total minimum contribution must be paid of 8% of the jobholder's qualifying earnings in the pay reference period
  • Of the above total, a minimum of 3% must be paid by the employer

Defined Benefit Scheme

  • A scheme which is contracted out will meet the minimum requirements.
  • A scheme which is not contracted out (or ceases to be) will need to provide benefits which are broadly equivalent to or better than a test scheme standard. This will be determined ordinarily by the scheme actuary.

Key features of the test scheme include the following:

  • Entitlement to a lifetime pension from age 65 (increasing to age 68 to reflect state pension age increases)
  • An annual pension of 1/120th of average earnings over the 3 tax years prior to retirement multiplied by service (subject to a maximum of 40 years service)
  • Revaluation of accrued benefits by a specific method
  • Escalation of benefits in payment at least in line with RPI capped at 5% or 2.5% depending on when the benefit comes into payment
  • Career average earnings schemes (CARE) must meet additional requirements in relation to the revaluation of benefits

Funding above the minimum qualifying earnings

Alternatively, if a company chooses to use an existing money purchase scheme and fund above the qualifying earnings bandings, then the rate of contribution will depend on how the company defines pensionable pay. This is summarised as follows:

  • A minimum 9% contribution of pensionable pay (including a 4% employer contribution) or;
  • A minimum 8% contribution of pensionable pay (with a 3% employer contribution) provided pensionable pay constitutes at least 85 per cent of the total pay bill or;
  • A minimum 7% contribution of pensionable pay (3% employer contribution), provided that the total pay bill is pensionable

Advice issues:

Advice is certainly going to be required by employers and company accountants alike as time marches on. A number of providers have already launched or are currently working on payroll software plug-ins, to assist with the sorting criteria and the calculations of the correct contribution rates, given the earnings bands dictated.

The Government is relying upon inertia for auto-enrolment to be a success. Certainly, in other countries where similar regulations exist it does appear to have a relatively low opt out rate, which may pose interesting times ahead for us all!