The pension system in the UK has been subject to constant change for decades; there is nothing unusual about that. But the changes being made by the two most recent Pensions Acts from 2007 and 2008 are surprising even in that context, for their scope and effect. In short, these changes, which are already on the statute books, will affect most businesses in the UK when they come into effect from 2012.
In my experience, very few employers know much about these fundamental changes that will affect them and their businesses, and that includes FDs, but that will clearly need to change as we approach the 2012 implementation date.
At the moment, there is no compulsion on employers to run workplace pension schemes for their employees other than the compulsion inherent in the state pension provision through the National Insurance system; the State Second Pension. From 2012 it will be a legal requirement that all employers with ‘eligible’ employees auto-enrol them into a Qualifying Workplace Pension Scheme, or QWPS. Employers will not be able to ignore this as it is part of the ‘duty’ laid on them by the Pensions Act 2008 and there will be heavy fines coming their way if they fail to meet the requirements.
Strangely enough, even though employers will be compelled by law to auto-enrol their eligible employees into funded workplace pension schemes, there will be no compulsion on employees to remain as members of a pension scheme if they do not wish to.
Employees will retain the right to opt out of schemes into which their employers are required to auto-enrol them; a process some employees may go through many times in their working lives as it will also be the duty of employers to re-enrol such opt-outs at three-yearly intervals.
Employees who choose to remain in the workplace pension schemes into which they are auto-enrolled will, after an initial phasing period, be required to contribute 5% of a band of earnings called qualifying earnings into the scheme, with the employer required to add a further 3% of qualifying earnings again after a period of phasing (the qualifying earnings band is currently set between earnings of £5,035 per annum and £33,540 per annum.) The 5% employee contribution is the gross figure allowing for basic-rate tax relief on the pension contribution; it’s sometimes described as a 4% contribution by the employee and a 1% contribution from the taxman.
It is interesting to note that employees who do opt out, and thus forego the compulsory minimum employer contribution of 3% of their qualifying earnings, may not be recompensed for that loss by their employer. Such a payment to offer parity with those who remain auto-enrolled would be deemed to be an ‘inducement’ for employees to leave a pension scheme, which is something employers absolutely must not be seen to do under the new regime. That rule could have far-reaching effects on existing pension arrangements run on the so-called ‘flex benefit’ basis a whole other conversation. Indeed, many of the detailed pieces of this new legislation will undoubtably lead to potential changes to existing workplace pension practices and look set to make the years in the run-up to 2012 very interesting years indeed.
The existing pension arrangement that will be replaced by these new employer-sponsored workplace pension schemes is the State Second Pension, or S2P. For decades, the state has provided earnings-related workplace pensions for employees in return for earnings-related National Insurance contributions levied on both employees and employers. It is worth noting, however, that workplace pension saving after 2012 will be voluntary as far as employees who can opt out of workplace schemes will be concerned.
The opposite is the case today. Since 1961 when the first State Second Pension, called the graduated pension, was introduced, workplace pension provision for all employees earning above a minimum level has been compulsory; it has not generally been possible to elect to not pay National Insurance contributions.
The graduated scheme, the State Earnings-Related Pension Scheme (Serps) and their modern equivalent S2P were pay-as-you-go schemes run by the state using the National Insurance system and utilising the efficiencies of the Department for Work and Pensions and its predecessors. There has been no national insurance fund as such, but running schemes on a pay-as-you-go basis is quite common elsewhere in Europe. Indeed, many of our public sector pension schemes in the UK are run on just that basis; nothing wrong with that.
What will be different in the future, though, is that the compulsory workplace pension system run by the state is about to be replaced by a voluntary workplace pension system run by employers that will depend on the power of inertia to ensure maximum coverage. My worry is that, by moving from a compulsory system to a voluntary system we will, in effect, end up with fewer employees saving for the future than do so today.
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Steve Bee is head of pensions strategy at Scottish Life