5 Sept 2016
Four years ago the starting gun was fired on a workplace pension revolution. Known as auto-enrolment, its aim is to ensure we all have enough income to live on when we get old. Adam Bernstein explains.
Adam Bernstein
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Image: Topp_Yimgrimm/iStock.
Auto-enrolment provides a starting point for retirement preparation as employers enrol eligible staff into a company pension and contribute to it.
As Nathan Long, a senior pension analyst at Hargreaves Lansdown, noted, eligible staff are aged between 22 and state pension age earning the equivalent of £10,000 a year or more: “The contributions start low [just 2% in total with at least 1% from the employer], but reach a total of 8% by 2019 [of which at least 3% must come from the employer]. Employees can opt out, but not before they are enrolled.”
Auto-enrolment started with the largest employers, but the continued roll-out means small employers must also tackle workplace pensions – small practices are not exempted.
“The first step is for employers to find out when they must comply, as failure to do so can lead to fines of £50 to £10,000 per day,” Nathan added.
Employers can find out their start date by visiting The Pensions Regulator’s website armed with their payroll reference number.
It’s important to remember employer responsibilities don’t stop once an auto-enrolment scheme is up and running as there are several ongoing requirements, including:
Employers must also be aware of any legislative changes. Recent tinkering has reduced the burden on employers, including pushing back the two increases in minimum contributions by six months. These will now occur in April 2018 (increasing to five per with a minimum of 2% from the employer) and 2019 (increasing to 8%, with 3% required by the employer) – they could rise further.
Moving on, most should know that saving for retirement is vital – the new state pension of £155.65 per week is simply not enough for people to live on.
Just how much income is needed is a tricky question to answer, Nathan suggested somewhere between half and two thirds of pre-retirement earnings should be enough for most. To get to this point does require time. “Contributing 15% of pay [including any employer contributions] over an entire working life should leave most people well placed when retirement comes,” added Nathan.
The number of workplace pension providers is huge, but there are two main types: group personal pensions (including group SIPPs) and master trusts. As a result of auto-enrolment there has been an explosion in the number of small master trusts, and question marks exist around the security of some of them. As such, Nathan says it is important for employers to be confident their choice of pension will be around for the long haul.
An alternative is NEST (National Employers Savings Trust), a pension scheme introduced by the Government, with a duty to accept any employer. Whichever route is followed, employers should ensure they understand all the costs, as some providers will charge a scheme set-up fee.
Apart from auto-enrolment, two further pension changes have been introduced. The first, from April, is a new state pension of around £8,000 per year. The old basic state pension paid around £6,000 every year, but people could receive more depending on how much National Insurance they had paid. Nathan reckons lower earners could be better off under the new state pension, but some higher earners may be worse off. He recommends anyone approaching retirement should contact the Department for Work and Pensions for a personal projection.
The second change gave people more freedom when accessing their pension, resulting in three main options:
A combination of these options is also possible. When the new flexibility was introduced in April 2015 there was an initial rush to take small pension pots out as cash, although taking larger pots as a one-off lump sum – the “Lamborghini option” as one Government minister coined it – proved less attractive as, while 25% of the pension fund can be withdrawn tax free, the remainder is taxed as income, which can often be penal.
Low interest rates and a natural tendency for people to underestimate how long they will live (annuities stop paying out in the event of death) had made annuities unpopular with retirees, many of whom felt it was their only option. But annuities still have a big role to play in providing retirement income.
While people are capable of managing their own affairs and remaining invested, it isn’t right for everyone. Many people at retirement are giving up the security of a salary and crave the certainty an annuity provides. Staying invested can look attractive when passing monies to beneficiaries in the event of death, but there is also the danger of running out of money, a problem that simply doesn’t exist with an annuity.
A solution for many will be to split their pension fund. Part can be used to buy an annuity to cover the essential spending needs, while the remainder can be invested to provide any discretionary spending.
This freedom, alongside the abolition of a default retirement age, looks set to accelerate the shift towards semi-retirement. This is where people work reduced hours while drawing from their pension to supplement their earnings. Research has shown 58% of employers are anticipating an increase in part-time working among older staff.
Claire Rosser, of the SPVS secretariat, can, like the Government, see the need for workers to save. However, she has concerns over what people are actually doing. “Individuals are going to need to make greater provision for themselves in retirement, but, in most veterinary practices, I am not sure the level of contributions and the current investment environment will produce a sum that achieves this aim,” she said.
While pensions auto-enrolment isn’t the ultimate solution, she thinks anything is better than nothing.
But while the new regime is, in theory, helping, it’s not cheap. Claire considers it as an extra cost to practices and says she has heard of some practices reducing the annual pay rise after auto-enrolment has started. Clearly, time will tell as to how staff pay has been affected.
Many businesses and organisations appear unaware of the ongoing obligations set by recent pensions law (to re-enrol all staff every three years and to confirm any changes to The Pensions Regulator every 18 months, to name two). It’s easy to see The Pensions Regulator will have an open field of play when levying fines for non-compliance unless, of course, it does a better job of publicising the rules of compliance.
In terms of setting up a pension scheme, the advice from Claire is that no matter who practices choose – independent provider or the Government’s own National Employee Savings Trust – the choice needs to be carefully made. She said: “The employer would want to choose a provider who is going to charge the lowest fees, but provide the best returns, and that’s not an easy judgement to make.”
On the new pensions freedoms (the right to take a whole pension pot from age 55) she thinks few, and especially the younger, members of a practice are aware of this, and added: “It will only become of real interest if the pension pot becomes significant. For those with significant pensions it has now become an excellent way to plan for inheritance tax.”
Pensions are like anything else in the workplace, a differentiator between employers as to who offers employees the best benefits. Claire can foresee an employer’s contribution rising to five per cent, or more, and way beyond the three per cent the Government plans for 2019.
