Most final salary Defined Benefit (DB) pension schemes are now closed to new members and/or further accrual, placing future burdens on employers after accrual. If DB schemes, which place financial risks squarely on employers, are an expensive highwater mark of paternalism, the form of workplace pension provision now becoming dominant,
Defined Contribution (DC), is an expression of a more individualistic age, with employees bearing the financial risk.
Yet two recent changes in the UK’s pensions system arguably mean employers are now under greater pressure to be more proactive in ensuring employees are saving enough for retirement: the introduction of so-called pension freedoms, or ‘Freedom and Choice’; and the creation of auto-enrolment pensions.
Auto-enrolment pensions have drawn millions more people into saving for retirement, but contributions will need to increase if these pensions are to deliver a decent retirement income; and this could increase costs for employers. Freedom and Choice has encouraged more DB scheme members to consider transferring into a DC scheme; and increased demand for independent financial advice to help individuals make good financial decisions.
The choice is yours
The Freedom and Choice reforms, announced by the then chancellor of the exchequer George Osborne in 2014 and introduced a year later, allow people with DC pension pots much more flexibility in how and when they use their pension savings, although some courses of action could result in high tax liabilities.
As John Gaskell, head of personal financial planning at ICAEW, points out, while more flexibility and choice are welcome, they also introduce complexity and risk: to individuals’ personal finances and to public finances if more people end up relying on the state for additional financial support after they have spent their pension savings.
The 2018 Financial Guidance and Claims Bill requires scheme trustees to ensure that anyone accessing pension savings is “referred to appropriate pensions guidance”. Several government-backed information services will merge this year to form the Single Financial Guidance Body.
Trustees may have to consider the implications from the increase in transfers to DB schemes. The value of DB to DC transfers doubled to £21bn during 2017, according to the Financial Conduct Authority, and this figure is expected to rise over the next few years, as many DB scheme members reach their mid to late 50s.
Paul Garwood, director at Smith & Williamson Financial Services, says: “For some, a transfer will allow those with a reduced life expectancy to either buy an impaired life annuity that is higher than the defined benefit pension they are giving up or leave a potentially sizable fund for their heirs. Some sponsoring employers may be happy for the scheme to offer an enhanced transfer value to reduce their future liabilities to the scheme although those with any form of pension protection need to be careful that any enhancements do not prejudice this.”
Anyone seeking to transfer DB pension rights worth more than £30,000 is now obliged to seek independent financial advice. For some this may be onerous. “They may also struggle to find an adviser,” says Ian Neale, director at Aries Insight, which provides guidance on the implications of changes in pensions-related legislation. “Then they’ll have to pay a fee irrespective of the advice they receive – which might be, ‘don’t transfer’.”
But employers can also now spend up to £500 per employee on access toan authorised Independent Financial Advisor (IFA) without this being regarded as a benefit in kind. Access to accurate information may protect individuals from exploitative and criminal activity.
“We’ve seen from what happened with British Steel that if people are not provided with good information they are vulnerable,” says Carolyn Saunders, partner and head of pensions at legal firm Pinsent Masons. Some former members of the British Steel Pension Scheme (BSPS) lost pensions rights worth hundreds of thousands of pounds in 2017 after being convinced to transfer out of a new pension scheme (BSPS2) to which their pensions might otherwise have been moved following financial restructuring at Tata Steel.
Over 2,600 scheme members chose to transfer, with the average values for those transfers being around £400,000. In 20 cases the transfer value was more than £1m. The scandal helped encourage The Pensions Regulator to revise guidance on best practice. Some employers have the resources to create comprehensive financial information services for employees. Such services can be both valuable and reputation enhancing for employers, but they – and perhaps, in some circumstances, the accountants helping them – must always remember to stay on the right side of the line dividing information and guidance from financial advice.
Counting the cost
Auto-enrolment has been a success. By the start of 2018 there were more than nine million people enrolled in auto-enrolment pension schemes; and the percentage of UK workers who are members of DC workplace pension schemes has increased from 43% for men and 40% for women in 2012 to 73% of all workers by 2016, according to The Pensions Regulator.
The problem with auto-enrolment pensions is that in most cases the contributions being paid are too low. For the first three years following the launch of auto-enrolment, minimum employer and employee contributions have each been just 1%. In April 2018 the employer’s contribution rose to 2% and the employee contribution to 3%.
In April 2019 they will both rise again, to 3% and 5%. While official statistics have yet to be published detailing any effect of the first of these increases on opt-out rates, there is no indication as yet that they have increased to any significant degree. While this will benefit workers, it will also increase costs for employers, at the same time as they are affected by increases in the minimum wage and other rising costs.
The changes in contribution rates, alongside annual increases in the upper and lower levels of qualifying earnings, add complexity to administrative and payroll functions. Liz Cole, manager, business law, at ICAEW, says she knows of some accountancy firms operating payroll for clients that have been adversely affected by a difference in opinion between software providers and the Pensions Regulator as to how to implement changes that came into effect on a different day in April (the 6th) to the day in the month from when some employers calculate pay (the start of the month). ICAEW is seeking to ensure members don’t have to grapple with this problem again in April 2019. “You don’t want to be doing manual reconciliation,” says Cole.
The government also proposes removing the lower earnings limit for auto-enrolment employer contributions, currently set for annual earnings of £6,032 or £116 per week, meaning contributions would instead be calculated from the first pound earned; and lowering the age eligibility threshold from 22 to 18. The latter measure could bring a further 900,000 people into auto-enrolment schemes, including many who now work in multiple, low-paid jobs. These changes, likely to be implemented by the mid-2020s, could be good for those workers, but will increase costs for employers. “The removal of the lower earnings limit will hit smaller employers quite hard, especially sectors such as catering, hospitality and retail, where low margin businesses already struggle,” says Cole.
Many employers will also be monitoring developments related to gig economy workers, particularly those classed as ‘self-employed’ but who work for the same employer all the time. In June 2018 the Supreme Court upheld a previous judgement against Pimlico Plumbers, meaning some gig economy workers can be classed as workers under EU law, enabling them to access employment rights including the right to be auto-enrolled in a pension scheme. Bringing these workers into the fold will increase the costs and administrative burdens facing employers, although hope - fully the benefits it delivers for gig economy workers will also help many accountants’ clients.
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