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A penchant for pensions
Everyone needs to get excited about pension saving in 2012, according to Steve Webb, the minister tasked with reinvigorating occupational pensions provision. This is clearly a ‘big ask’ - but then Webb has a big stick with which to beat those employers who fail to pick up on his enthusiasm.
‘Automatic enrolment will begin on time this October, taking up to 10 million people into pension saving - many for the first time ever - and all employers will be part of it,’ he says. Webb’s belief that a new wave of first-time pension savers will be created from this year is borne out by a snapshot of workplace practices revealed by the Gazette’s recent online pensions survey. Auto-enrolment will see many law firms provide a pension scheme to their employees for the first time. Over half of all respondents said that their employer did not currently provide such a scheme, which is perhaps unsurprising given that most of those surveyed worked for businesses employing fewer than 50 people.
As Webb has indicated, from October some 10 million employees will start to be enrolled in a pension scheme automatically by their employer. Between that date and 2017, every employer, no matter how small, will have to implement a staff scheme or face the threat of fines and even jail. There are tough penalties for non-compliance. An immediate fixed penalty of £400 is followed by escalating sanctions, ranging from fines of £10,000 a day for firms with over 500 staff, to £50 a day for those with four staff or fewer. The penalty for persistent non-compliance is up to two years in prison, while ‘prohibited recruitment conduct’, such as trying to persuade staff to opt out, also carries swingeing fixed penalties. Yet less than one-third of small firms know their ‘staging date’, according to research by the Chartered Institute of Personnel and Development. This is the date at which employers could be prosecuted if they do not have a scheme in place; and pensions experts are warning that it will take at least a year of planning ahead of that staging date to implement a suitable scheme.
‘Those employers who expect auto-enrolment to involve nothing more than some additional, straightforward administration are in for a rude awakening,’ declares Mark Hodgkinson, co-founder of pensions consulting group Muse Advisory. ‘Smaller firms need to heed the lessons learnt by the largest employers, who are already steeped in their preparations. The key lessons are: start early and appoint an effective project manager to drive the process. The potential financial sanctions for failure make non-compliance a distinctly unattractive option.’
Pensions and performance
As scary as these sanctions might appear, there are considerable advantages to firms in terms of staff retention and motivation from providing a good pension scheme. Pensions are the most valued employee benefit, research consistently shows, a finding confirmed most recently in surveys by Aegon/Edinburgh Business School and YouGov (see second box, below). According to employee benefits specialists Wesleyan, 42% of lawyers said an employee benefits package which included a pension was ‘important’ or ‘very important’ to them when it came to choosing a new job.
‘Our experience in advising both individual lawyers and law firms is that pensions with employer contributions are a key part of any recruitment and retention model,’ says Jon Parker, business development manager at Wesleyan for Lawyers. He also believes that law firms should factor in the retention, recruitment and motivational benefits to their firm’s bottom line when deciding not only which scheme to enrol staff in, but also what level of contribution they will be making to their employees’ funds.
For auto-enrolment, the minimum employer contribution has been set by government at 3% of an employee’s earnings. However Tim Jones, chief executive of new national top-up pension scheme the National Employment Savings Trust (NEST), which is also the government’s scheme of last resort, says that 75% of the 50 companies which have enrolled their employees into NEST ahead of auto-enrolment’s launch in October are paying in more than this minimum. The average contribution by employers currently sits at 5%. While this is more than the legal minimum, it is still much less than employer contributions into many existing corporate pension schemes.
The Gazette’s online pensions survey found that some legal sector employees were receiving employer contributions equal to 15% of their annual salary into their pension pots. Taking employee and employer contributions together, those who answered our survey and had so-called defined contribution (stakeholder, trust or group personal) pensions had combined contributions of between 8% and 20%. This range is more generous than UK provision as a whole. The annual pension trends survey by the Association of Consulting Actuaries (ACA) calculated the average DC combined contribution at between 7.5% and 13% in 2011.
Fewer than one in five of those who responded to our snapshot had a so-called defined benefit (DB) (final salary or career average) pension, but some 86% of those who do work in the public sector. According to the ACA, the average combined contribution into an employee’s DB scheme was 27% last year, although none of those in our snapshot with DB schemes were prepared to reveal their combined contribution level.
A key benefit to employers of not waiting until the last minute to set up their pension scheme is the forecast impact on the bottom line. Peter Glancy, head of corporate propositions at pensions giant Scottish Widows, explains: ‘One of the reasons you might want to do something early is that auto-enrolment is going to be a bit of a shock to your cashflow. At your staging date, all of a sudden you are going to have to put in 3% of your salary bill as a contribution into a pension. However, if you start in advance of your staging date you will be able to take that cashflow hit a bit more gradually and, in addition, you will also be able to offset the contributions against pay rises that you may want to give to your employees.
‘So for example, if you are planning to give your employees a 3% pay rise for each of the next three years, you might only give them a 2% increase and use the other 1% to put into a pension scheme. And then of course, when the staging date comes, from the employer’s point of view you don’t have that strain on your cashflow, and from the employee’s point of view they’ve got a little bit in their pension fund ahead of [time]. However, what you can’t do is wait until your staging date and then give all your employees a 3% wage cut in order to put the money into the pension fund - it is illegal to do that under the new legislation.’
Do not be an ostrich
Despite the obvious advantage of starting an auto-enrolment project sooner rather than later, the ACA found that 74% of employers had so far failed to budget for the establishment of a pension scheme for their entire workforce. Even the 26% who had budgeted for auto-enrolment might find their cost calculations wide of the mark. The association says that most employers are assuming that between 25% and 40% of their staff will opt out of joining the proffered scheme. However, the experiences of other countries which have introduced similar rules suggest opt-out rates could be considerably lower: the opt-out rate for New Zealand’s KiwiSaver is just 11% for example. This means that employers (who are banned from encouraging their employees to opt out, remember) will need to ‘scenario plan’ the impact of different numbers of scheme members on their cashflow.
As important as deciding what level of contribution an employer will make will be working out what counts as ‘salary’ for the purposes of auto-enrolment, according to Scottish Widows. Qualifying earnings for auto-enrolment include not just salary but a number of variable payments such as bonuses, overtime, commission, shift allowances and some statutory payments, including maternity pay.
This change will affect not only employers setting up pension schemes for the first time, but also the contributions employers make to existing pension schemes, as these may have to be increased once the new earnings limits are factored in. Glancy says: ‘Employers may want to choose a different definition of salary. There are different percentages that you need to pay depending on which definition you go for. Where a firm has got people with part-time wages and bonuses, for example, how these are recorded will matter. Depending on which definition [of salary] you go for, it could cost you more or less as an employer.
‘So there may be implications for existing contracts of employment and therefore firms may have to get an internal or external legal view. Working your way through all of this really complicated legislation and then figuring out how you are going to comply with it is going to be a big challenge, especially for smaller organisations that don’t have HR experts.’ The good news for employers is that there is a whole industry out there eager to assist. All of the big pension providers and employee benefits consultancies, as well as NEST, have created modeling tools - many available over the internet - which will help employers work out what the impact of the different contribution levels and salary definitions will be.
Next up for employers will be the choice of pension provider. Here it is important to point out that NEST is just one potential choice in this regard, albeit the one with a statutory obligation to accept all employers who ask it to enrol their employees. The UK’s largest pension providers, including Aviva, Standard Life, Scottish Widows and Legal & General, are falling over themselves to attract employers on the back of auto-enrolment because they recognise an opportunity to attract new savings to their organisations.
Employers who already offer a pension to some of their staff will need to consider if this should be rolled out to all employees or if an alternative option will be more appropriate. NEST’s Jones says: ‘A lot of people are joining us ahead of their staging dates as there hasn’t been a suitable product for their support staff until now. There is a lot of pent-up demand from people who wanted to offer a pension before but were not really catered for by the market.’
NEST is currently working with around 130 employers to bring some or all of their employees into its scheme. Employers will also need to think about an appropriate level of choice for their employees. Some pension providers offer literally hundreds of fund choices to scheme members. But all the evidence from existing schemes is that the vast majority of employees - in excess of 90% in some schemes - opt to save into the default fund. This is the fund into which contributions are placed when an employee fails to specify an investment option.
In short, employees will not necessarily thank an employer for providing them with a plethora of investment choices. NEST itself offers just five fund options: a retirement-date fund; a higher-risk fund; a lower-growth fund; an ethical fund; and a sharia fund. Jones expects around 90% of employees enrolling with the organisation to end up in its default option, which is the retirement-date fund. In reality this is actually a series of funds that will seek to manage investment returns and risks, dependent on when an employee wants to retire.
‘Think of it [the retirement-date fund] like a car,’ he explains. ‘Not many people are interested in what is under the bonnet of a Ford; similarly, with the retirement-date fund people are not over-burdened by what is underneath - they just know when they want to retire.’
The final thing employers need to consider is the administrative side of auto-enrolment. As already mentioned, the pensions industry is falling over itself to win business on the back of auto-enrolment. Employers should check what tools a pension provider offers to help them not only manage their employee pensions, but also to comply with the reporting requirements of auto-enrolment. Glancy of Scottish Widows adds: ‘Employers are legally responsible for complying with the legislation’s reporting requirement, and while product providers cannot take that responsibility on for them, we want to give employers the tools to make that compliance much easier to achieve and reduce the time taken to comply, as well as the administration overhead of compliance.
‘We are therefore building something called an auto-enrolment assistant that will basically have all the new rules built in and computerised. Then all the employer has to do is put through a monthly file of who the employees are, how much they earn and so on, and the tool will do the rest. As well as sending the data through to us so that we can take care of things at our end, it will also produce the various outputs which are required by the [pensions] regulator.’
The significance of selecting a suitable administration tool for auto-enrolment should not be underestimated. Jones explains: ‘Every new employee triggers a new enrolment. In addition, any employees who opt out have to be offered re-enrolment every three years, and we can capture that data and tell the employer when they need to be re-enrolled.’
Many employees being auto-enrolled will also be new to pension saving, so the way in which the chosen scheme is presented to them will be critical - especially if employers are to reap the above-mentioned rewards from providing a decent scheme.
Jones says: ‘The financial services sector does not have a good record for explaining things clearly. At NEST we have spent a lot of time looking at the language around pensions. We realised not only that people didn’t understand pensions, but also that they didn’t understand the phrases used around them as well. So we have done a lot of work around the jargon.’
The options relating to what employee statements will look like, as well as how employees will be given access to their pension statements, also need to be considered. Firms would be sensible to test the various provider options with some of their employees for ease of understanding before making the final decision on a provider.
There are definite financial advantages for firms in not leaving auto-enrolment to the last minute. Offering a decent pension is proven to be a sound business move, and there is an abundance of suppliers and advisers out there ready, willing and able to help you out. At a price, of course.
Michelle McDonald is a freelance financial journalist