Getting personal

With further pension reforms on the horizon, firms will play an ever-more important role in incentivising their employees to save for their retirement.

By Robin Hames

The latest Pensions Bill has recently passed to the House of Lords for further debate. For those who don’t spend their working life following pension legislation, this might come as a bit of a surprise: the last sweeping reforms of pensions came into effect in April 2006.

And indeed they were sweeping. The multiplicity of different pensions arrangements with varying rules on contribution limits and benefit structures was replaced by a unified, simplified single tax regime. Unlike previous reforms, the reforms were, in effect, retrospective; albeit that this has led to a proliferation of transitional rules to cover innumerable scenarios in respect of benefits built up prior to 2006.

So why the need for further reform?
The current Bill is not intended to radically alter the legislation that became effective two years ago. Rather it seeks to build on an earlier reform programme of the current administration.

In 2001, stakeholder pensions came into being amid great government fanfare and acclaim.

As you may recall, the principle aim of stakeholder pensions was to motivate more people to save for their retirement. In order to meet this objective, stakeholder pensions were introduced as a simple low-cost alternative to personal and occupational pension schemes. All employers (with a few caveats) were required to designate a stakeholder scheme and allow employees to save into the arrangement through payroll deductions.

In effect, the proposed legislation is ‘son of stakeholder’ and a tacit admission that the stakeholder experiment has failed. However, it has to be said that I have yet to hear a government official make such an admission!

While over a £1bn worth of monies have been saved into stakeholder pensions over the past seven years, it is very difficult to assess how much of this represents ‘new’ savings (as opposed to a redirection of existing pension savings). It is even harder to determine the extent to which new savings came from the target audience of mid to lower earners (as opposed to wealthier individuals using some of the tax loopholes created).

In response to this lack of success, the government proposes to introduce a national pensions savings scheme from April 2012, which has been named Personal Accounts.

The reasons for the failure of the stakeholder experiment to avert the ‘pensions crisis’ have been the subject of much debate both in government and within the pensions profession.

Two issues, both of which are specifically addressed in the forthcoming legislation, are of particular relevance for finance directors.

Stakeholder is deemed to have been fatally handicapped by the requirement for individual activism and the lack of incentive, beyond the scheme’s low charging structure, to save.

The proposed reforms
Legislators are determined that the new Personal Accounts pension scheme will not suffer the same fate.

If, as seems likely, the legislation is passed without significant amendment, then April 2012 will herald a further change in the pensions panorama. Not only will all employers be obliged to offer access to a Personal Accounts scheme, they will also be obliged to contribute into that scheme and automatically enrol employees into the arrangement.

In other words, contributory employer pensions schemes will be a legal necessity and participation will be driven by inertia: employees will have to take action to remove themselves from the scheme.

Furthermore, employers will be required to automatically re-enrol non-joiners every three years. In other words, those employees who do opt-out will have to regularly repeat the exercise in order to avoid saving for their retirement.

The box out on the following page provides an overview of the detail regarding required contribution levels and the auto-enrolment system.

The potential impact for law firms
The vast majority of respondent firms from our 2007 Legal Sector survey offered their employees a pension scheme with an employer contribution. Less than five per cent of firms did not. Clearly, therefore, a small minority will need to consider the ramifications of a compulsory contributory scheme for their future financial models.

For those currently offering a contributory scheme, the issues to be considered will revolve around scheme design and exemption criteria. If a firm wishes to avoid the complication of offering both its own scheme and enrolment into the national scheme, attention will need to be paid to the exemption criteria – ensuring the firm’s own scheme meets the government definition of a ‘good’ scheme.

This may beg the question why firms should not simply abandon their own schemes and join the national arrangement. There are a number of cultural arguments that could be discussed in this regard, but other more practical issues will also need to be considered.

For instance, in its determination to target low to middle earners, the legislation proposes a low maximum annual contribution: this is likely to make the Personal Account scheme unattractive or impractical for higher earning associates, salaried partners and management teams.

Therefore, in the run-up to 2012, scheme design issues such as eligibility periods, contribution levels and the definition of salary for pension purposes will need to be addressed. Clearly, where governance committees (as discussed in my article in the last issue of FD Legal) have been created, the implication of Personal Accounts will become increasingly a feature of their agenda. In their absence, it will be vital that finance and HR teams work together through other processes to avoid unforeseen budget implications.

Indeed budgetary issues are bound to have an influential role in decision-making. It may be that the inconvenience and complications of a dual pension scheme is outweighed by the cost of the necessary benefit design restructure to avoid such an outcome.

The impact of auto-enrolment
The key reason for this lies in understanding the inertia effect of auto-enrolment on scheme take-up.

While present in the current pensions system, auto-enrolment will almost certainly become omni-present after 2012. Currently, there are difficulties with applying auto-enrolment to workplace schemes such as Group Personal Pensions, principally due to the application of certain EU Marketing Directives.

The Department of Work and Pensions announced in May that agreement had been reached with Brussels that will allow auto-enrolment across all workplace schemes by 2012. Auto-enrolment will therefore become the defining criteria of a ‘good’ scheme.

The impact of auto-enrolment on scheme take-up is evident. At present, where auto-enrolment is not in place, scheme take-up varies hugely among law firms: often directly correlated to the effectiveness of the benefits communication strategy.

Desirable take-up levels are a common point of debate in employee benefits governance committees and typical levels can range from 50 per cent to 85 per cent of eligible employees.

Evidence, from both the UK and US, would suggest that the range for schemes with auto-enrolment in place is more likely to be in the range of 80–95 per cent of eligible employees. Inertia works.

Therefore an important consideration for finance professionals where take-up is currently relatively low is to how to plan for the potential surge in benefit costs post 2012. Clearly this will be a greater issue for those whose annual pensions budget is based on actual rather than potential scheme take-up.

This may well prove one of a number of important points in debating whether a firm wishes to ensure its scheme is exempt or would prefer to offer its employee access to both its own scheme and the national arrangement.

Conclusions
2012 may seem a long way off to anyone other than the British Olympic Committee, but it’s important for finance professionals to keep an eye on the progress of the current Pensions Bill.

It’s important for firms that any benefit review and redesign takes into account the forthcoming legislation. While certain issues, such as means-tested benefits, threaten to jeopardise the broad cross-party consensus, it is very likely that the proposed reforms will change the pensions landscape again.

Failure to plan over the coming years for its arrival could have serious financial implication for law firms and all other employers alike.

Robin Hames is a consultant at PIFC Consulting. He can be contacted at robin.hames@pifc.com