April 2008

The need for common sense

From 2012, employers have to auto-enrol their employees into either the personal accounts scheme or their own pension plan. It makes sense that any 'exempt' pension scheme is of a certain standard. However, the effect of the requirements set out in the Pensions Bill goes directly against the two main aims of pensions reform - 'to complement and not compete with the existing market' and 'to help lower and medium-earning people save for their retirement'.

The Bill requires contributions to an exempt scheme to be at least equal to contributions for personal accounts - 8% of 'qualifying earnings', with a 3% employer contribution. 'Qualifying earnings' are earnings between £5,035 and £33,500, including additional payments such as commission, overtime and bonus.

However, this doesn't reflect current market practice, where many pension schemes base contributions on basic earnings only, but on the full amount, including the first £5,035.

To avoid falling foul of the new regime, employers will have to check each member's regular contributions match the personal account contributions, and if not make good any shortfall. Otherwise, the scheme will 'fail' the exempt scheme test, even if only one member is affected. This is difficult if employees receive a significant proportion of their overall income as bonus, commission or overtime. It's also more problematic in certain months when bonuses are paid or the overtime bill is higher than usual.

So, the pensions reform legislation is not complementing the existing market practice. Instead, it's introducing extra hurdles and burdens, and disturbing employers who have set up good pension schemes.

The industry can address this problem by putting in extra checks as part of payroll software or contribution collection mechanisms. However, to think that's the overall solution is missing the point.

Making up any shortfalls will be an extra expense for employers, even if employees share the cost. To temper this, and to remove the need for these checks altogether, the easiest approach for employers will be to change the earnings basis for their schemes to full earnings, but with the same lower offset as personal accounts. Medium earners may benefit from this change but lower earners will lose out if the value of their bonuses and overtime is less than £5,035.

Women, who earn less overtime than men, are likely to be badly affected. Worse still, some employers, may also reduce their level of contributions down to that of personal accounts, cutting their employees' retirement income. That's not helping lower and medium-earning employees save for their retirement.

There is a simple solution to avoid this. Allow an alternative definition for contributions: 8% of basic earnings, with no offset and a 4% employer contribution. Employers wouldn't have to carry out any additional checks, or disturb the pattern of good pension schemes. Lower earners would probably be able to keep a higher pension contribution and therefore a higher retirement income.

The Government worries that allowing such alternatives would encourage employers to reduce their employees' basic pay, and instead pay higher bonuses or overtime. I can't see that happening in practice. To re-negotiate pay takes effort, and employees will be resistant to a lower basic pay as it curtails their ability to borrow. It also makes it more difficult for the employer to recruit staff. Asking for a higher employer contribution in any alternative definition should also dissuade any employer looking for an easy get-out clause from their responsibilities.

The Government needs to apply a bit of perspective and common sense to this problem. Inventing new hurdles and checks for employers will only put off the 'good' ones, the ones who help their employees to save.

Rachel Vahey
Head of Pensions Development
AEGON Scottish Equitable