What do the compulsory pensions changes mean for your business?
As compulsory contributions to staff pensions loom, now’s the time to assess your options
Staff: costs on legs or your greatest asset? You need to recruit and retain the right people to remain competitive and innovative so surely you can decide how you pay for them?
Not entirely. Your payroll system collects tax and National Insurance for the government and, if Adair Turner’s Pension Commission recommendations are adopted, you’ll help plug the pensions hole too. After all, you’re in partnership with the government and fi nancial services providers to combat the nation’s pension-apathy whether you like it or not.
Although 92% of you already offer some form of pension provision, the Department for Work and Pensions (DWP), in its Family Resources Survey (2002/03) estimated that some 4.6m employees have not joined employer-based pension schemes to which they have access probably making it seem a complete waste of time and effort.
Poor fund performance, plummeting annuity rates and misselling scandals have all contributed to record low savings rates. In many cases it’s simply a case of cash now over cash to come.
Pensions are very important to staff though, argues Robin Ellison, chairman of the National Association of Pension Funds (NAPF). “They’re expensive and ineffi cient to organise individually rather than collectively and as recruitment, retention and redundancy tools they are without peer,” he says. “If someone has been working for an employer for a long time they do feel pressure to look after them in their old age. Even non-paternalistic companies like Google realise this.”
The value of pensions
If there was clear evidence that an employerfunded pension scheme had a direct correlation with enhanced employee retention and candidate attraction surely there would be more in operation? However, pensions featured nowhere as a retention tool in the Chartered Institute of Personnel and Development’s (CIPD) recruitment, retention and turnover survey.
Total employer contributions to private pension schemes increased from £37bn in 1996 to £69bn in 2004, according to the Offi ce of National Statistics. But over the same period, employee contributions only moved from £14bn to £21bn.
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So why bother? An ABI (Association of British Insurers) study showed that only 17% of basic rate taxpayers and 28% of higher rate taxpayers were aware of how much tax relief they were entitled to on pension contributions. As an employee benefit it’s tough trying to make some- thing as complex as pension scheme provision as easy to understand as cash, a company car or childcare vouchers – but simplification rules (see box) are supposed to change all that. We’ll see…
For you though, the benefi ts are clearer: namely a favourable tax and NI treatment at the contribution end and tax relief on staff contributions. At least 25% of the accrued fund is tax free when the employee takes the pension. Even better, the cash put into the scheme by you is not taxed at source and neither is it taxed as a benefit in kind (unlike a company car).
But, faced with indifference many employers have found themselves wondering whether doing more than the bare minimum is worth it. Sally Toumis, managing director of recruitment agency Star Brooks operates a stakeholder scheme for her 18 employees with absolutely no take-up. The agency does not make contributions. “Many have families to support and would rather have a good salary – the average age is 32,” she explains. “I feel very angry about compulsion – it’s not right to have people dictating to us how we reward our staff and it doesn’t help retention at all. Compulsion is a threat to growing businesses and those contributions would have to come out of our pay budget.”
Only approved occupational schemes carry the full range of tax advantages available and employers have to contribute to them. Normal Retirement Date (NRD) needs to be the same for men and women (at present this is usually 65). You can impose a minimum age (e.g. 21) and service period provided a stakeholder scheme is available to all employees. Don’t exclude part-time workers as this could be interpreted as sex discrimination.
Information has to be disclosed to members about the scheme and its operation. A trust separates scheme assets from those of the employer – protecting the fund. Trustees can include representatives of the employer and scheme members. They are responsible for the assets of the scheme and monitor the performance of the investment advisers.
The main difference between defi ned benefi ts (DB) and defi ned contribution schemes (DC) is risk. You cover the openended cost commitment of a DB scheme including any funding shortfall. It is unlikely you would want to be taking on an obligation to cover a fixed rate of benefi t (a fraction of fi nal salary) in the future when you have no idea what that liability is going to be. Back in 2000 there were still 34,000 of them – but there are fewer than 18,000 now.
Defined contribution schemes operate by paying defi ned sums into the scheme to build up a fund that is later used to provide the member’s retirement benefits. You can vary employee contributions according to criteria such as age, length of service or to the percentage of salary contributed by the employee.
It is possible to operate schemes where the employee does not contribute, but employee contribution improves the overall scheme fund, reduces employer cost and reinforces the value of having the scheme to the member because they have invested their own cash. Accrued benefi ts can be taken as income withdrawals or used to purchase an annuity. Costs of purchasing an annuity have risen in recent years, reflecting falling interest rates and increased life expectancy.
Group personal pensions
With a GPP, benefits are flexible while the administrative burden is the responsibility of the product provider. This distance between the employer and the scheme could reduce its perception as a benefit, though good internal promotion should avoid this.
The employee’s contribution is deducted from net pay (i.e. after tax and NI) and the product provider reclaims the basic tax rate relief and adds it to the fund. Higher rate taxpayers claim higher rate tax relief through the self-assessment process when filing their tax returns.
These are low-cost, government-regulated personal pensions available from a number of pension providers listed by the Pensions Regulator. You must provide a stakeholder scheme if you employ five or more staff unless an occupational scheme is in place available to all employees (except for under-18s and those within five years of retirement).
You’re exempt if you offer a GPP contributing at least 3% of basic pay and no exit charges for the individual. Providers cannot charge those joining a stakeholder scheme after April 6 2005 more than 1.5% of the value of the fund for the fi rst 10 years. This reduces to 1% after that and those joining schemes before that date cannot be charged more than 1% as long as they remain in the scheme.
The minimum level of contribution cannot be set above £20 – and this could be a one-off or regular payment. Check your provider has a default investment fund if your employee doesn’t want any involvement in choosing where the contributions are invested. Take-up has generally been low – possibly because few employers have contributed, leaving little advantage to the individual over their own personal pension.
Other personal pensions
Another option is to contribute to your employee’s existing personal pension arrangements. This will be highly valued as a benefit by the employee – not only because they have already started the scheme themselves but because of the tax efficiency of the contributions. The individuals need to monitor the annual premiums limit when considering employer and employee contributions.
Even though the chancellor has removed the tax advantages for Self Invested Personal Pensions (SIPPs) to invest directly or indirectly in residential property and other tangible assets such as artworks and vintage wines, SIPPs remain a useful option for individuals with access to good fi nancial advice and a hands-on interest in portfolio management.
How much will it all cost?
You need to decide what contributions (if any) you are going to make to the pension scheme and if you want different levels of contribution.
Tony Marshall, an independent financial advisor says you should negotiate with your provider for a reduced fee for larger contributions and distribution costs as commission is factored into the annual charge.
“Assuming you go down the DC route, most group schemes do not usually exceed 1% of the fund size but will cost you at least 0.3% per annum. Ongoing costs can include ‘bid/offer spreads’ – the difference (normally 5%) between the price of buying a unit and selling it, monthly plan fees, administration fees (dealing with joiners and leavers) plus the annual management charge.”
However, since the stakeholder regime was introduced, most schemes now tend to be ‘single priced’ and don’t have these separate charges, he adds. It goes without saying that if you have high take-up your contribution and annual management charge will increase.
The logistics of buying
There are four types of adviser available and you need to be very clear about what you can expect from each type. The four are: tied representatives (e.g. those working for banks, businesses and friendly societies); multi-tied offering just a handful of companies; advisers offering ‘whole of market’; and independent financial advisers (IFAs).
David Wicks, MD of Finance Industry Training, used the Personal Finance Society and the IFA trade body – AIFA – to help direct him to advisers qualifi ed in the correct field. Star Brooks’ Toumis went to her bank for her basic stakeholder scheme. “Use the people that know you as an organisation,” she suggests. She also has her own SIPP.
Your accountant will more than likely have a network of IFAs but some are authorised by the Financial Services Authority to give investment advice themselves. An IFA is at least qualified to the level of Advanced Financial Planning Certificate (AFPC), with all-round market and product experience. Another plus is the capacity to service a large scheme and accessibility.
The timescale in establishing the scheme varies considerably according to the provider, the adviser and the size of the prospective membership. Delays can be caused by adding in extra benefi ts such as life and disability cover.
When it comes to the actual products there are some basic criteria and your adviser will be best placed to explain what suits you.
- What is the range of fund types (e.g. UK equities, properties, unit trusts etc)?
- Is there any opportunity for self-investment (important for SIPPs)?
Performance is very difficult to judge because the future is unknown and past performance is not a sufficient predictor. Get information on the financial strength of your provider, performance of fund links and their after-sales service.
You don’t have to contribute to employee pensions, but with compulsion on the agenda now is the time to review your options. There are tax advantages and the benefi ts are simpler to communicate. But until your staff actually take personal responsibility for their retirement the business case remains uncertain.
Top buying tips
- Decide what you want from a pension scheme first
- Defined contribution options reduce cost and risk
- Consider multi-tiered schemes to reward long service
- Use independent qualified financial advisers
- Check your provider’s past performance, financial strength, performance fund links and aftersales service
- Charges should be no more than 1% of fund total – ideally nearer 0.3%
- Ensure you have internal systems to process and record contributions
- Communicate the benefits to your staff. Your provider should help
You can compare some workplace pensions on our page on top UK auto-enrolment pension providers.
Some useful websites:
The Pensions Regulator: www.thepensionsregulator.gov.uk
Association of Professional Financial Advisers: www.apfa.net
Pensions and Lifetime Savings Association: www.plsa.co.uk
Association of British Insurers: www.abi.co.uk
Personal Finance Society: www.thepfs.org
Background to the new regime
After April 6 2006 (‘A’ Day)
- Single tax regime: contribution limit for 2006 capped at £216,000 rising to £255,000 at 2010. Total lifetime fund per person £1.5m
- Flexible retirement options to all staff permitted
- Annuities don’t have to be purchased before 75th birthday
- Individuals born after April 5 1960 can’t take early pension until 55 Turner recommendations (not yet law)
- All employees automatically enrolled into funded pension saving with the right to opt out
- National Pensions Savings Scheme (NPSS) to cover employees without access to a high-quality employer pension scheme
- Minimum individual contribution 4% with 1% paid for by tax relief
- Minimum compulsory employer contribution 3%
- Additional contributions above the default level by both employers and employees to be encouraged
- Individuals can say how the funds are invested
- Target annual management charge of 0.3% or less