Major reform has swept through occupational pension provision and it will affect every employer in the UK. Every business is being obliged to auto-enrol and contribute to their employees' pension schemes, with the final phase due for completion in February 2018.
Companies that fail to comply can face tough penalties, so now is the time to set up an occupational plan. If you do not already provide a pension scheme, you must identify a scheme which you can use to fulfil your duties as soon as the changes affect you.
1. The benefits
There is no escaping the cost of providing occupational pensions, but retirement schemes can deliver a number of benefits.
Providing a pension scheme will help you comply with the law
- Since October 2012, some businesses have been required to provide an 'automatic enrolment' scheme according to their 'staging date'. By February 2018 all businesses will have to comply.
- You must pay pension contributions for almost all staff, unless employees specifically opt out (see Pension reform).
You have flexibility over how you meet your obligations
- You can use an existing pension scheme, provided it meets the automatic enrolment criteria, or you can amend it so that it does.
- You can use your existing scheme for existing members (provided it is suitable or amended to meet the requirements) and set up another scheme for the rest of the staff.
- You can set up another pension scheme to fulfil automatic enrolment duties for all eligible jobholders.
- To amend existing arrangements, approach the current pension provider. Be aware that they are likely to promote only their own products or those of a limited number of suppliers.
- You are no longer required to provide access to a stakeholder pension scheme. However, if you have a stakeholder scheme, you must continue to pay contributions for all employees who are already members until they stop making contributions.
Contributions generally qualify for tax relief
- Employer contributions are treated as a business expense.
- Employee contributions benefit from income tax relief on contributions up to 100% of annual earnings subject to an annual allowance which is normally £40,000.
- The annual allowance is reduced by £1 for each £2 of income between £150,000 and £210,000. The minimum allowance is £10,000.
A competitive pension scheme is an invaluable employee benefit
- Providing a good company pension helps retain existing employees.
- It can improve your business' reputation as an employer and help you attract employees.
You can help employees save for a higher retirement income
- The new single-tier basic state pension is £159.55 per week for those that reach state pension age on or after 6 April 2016 and have accrued 35 years' National Insurance Contributions (NICs) or credits.
- Those who reached state pension age before this date will receive the old state pension of £122.30 a week if they have accrued 30 years' NICs or credits.
- There is a means-tested pension credit guarantee which will top your income up to £159.35 if you are single or £243.25 for couples.
2. Pension reform
Each employer is allocated a 'staging date'
- Staging dates are phased between October 2012 and February 2018.
- Once you reach your staging date, you must automatically enrol any eligible worker into a contributory pension scheme.
Employers must automatically enrol all qualifying workers into a pension scheme
- A qualifying worker is one aged between 22 and state pension age, whose salary is over the automatic enrolment earnings trigger (£10,000) and who is not already a member of a qualifying pension scheme.
- Non-eligible workers aged between 16 and 74 who earn at least £5,824 (entitled workers) have the right to opt in to the pension scheme.
- Employees who earn less than £5,824 have the right to join a pension scheme but the employer does not have to pay pension contributions.
Your pension scheme must meet the new standard
- You can use the NEST scheme set up by the Government or choose an alternative scheme (see Further options).
There is a minimum level of contributions that must be paid for eligible staff
- The minimum contribution is payable on earnings between £5,876 and £45,000.
- Employer contributions must be at least 1% of qualifying earnings.
- Total contributions (including employee contributions) must be at least 2%. So if the employer pays 1%, the employee must pay at least 1%.
- Minimum contribution levels rise to 2% (employer) and 5% (total) from April 2018, and to 3% (employer) and 8% (total) from April 2019.
- Employers and employees can choose to make higher contributions than the minimum required.
Eligible workers may decide to opt out, but must make a positive decision to do so
- Those who do opt out will be automatically re-enrolled after a given time.
- Workers may opt back in, but employers will not be required to accept opt-ins more than once every 12 months.
Employers who fail to comply face fines
- Daily charges can be up to £10,000.
- Employers who deliberately fail to meet their obligations can face criminal prosecution and even imprisonment.
3. Further options
Employers can choose to use the NEST scheme or another pension scheme. Offering a better scheme can attract and retain key staff.
You can continue to manage an existing scheme if it meets the qualifying criteria
- The rules vary for different types of occupational scheme.
- The easiest way to check is to ask the scheme's trustees or provider.
You can set up a new scheme
- A defined benefit scheme could be a risky choice. Unless you are certain of reliable long-term profits it could prove too expensive.
- A growing trend is for group personal pension schemes. These combine the benefits of personal pensions (particularly portability) with the benefits of group schemes (lower costs).
- Depending on the level of contributions and costs, setting up a new scheme could prove cheaper than maintaining existing plans but the benefits could be lower.
Check how much administration will be done by the pension provider
If you are planning to set up a new scheme, you should take responsibility for:
- transferring the employee and employer contributions to the pension provider;
- raising or reducing employee contributions, as requested (preferably at set intervals);
- dealing with enquiries from employees about payments in or out.
You have some flexibility over what to offer
Provided that you meet qualifying criteria, you can decide:
- What benefits you want to offer, eg death-in-service benefits, or ill-health retirement pensions.
- When you want to start contributing. Making contributions for two extra years could make a 20% difference to the pension of those due to retire in 2030.
- The rate of contributions. By increasing your contribution to 4% and employee contributions to 6%, after 20 years an employee's pension fund could be almost 50% larger.
Types of occupational scheme
Defined benefit schemes (DB or final salary schemes)
- DB schemes place the responsibility for funding pensions on the employer.
- They promise a pension related to earnings at retirement.
- Employees can hope to retire on two-thirds of final salary, though most will retire on considerably less.
- The schemes are revalued to ensure they still have enough assets to pay pensions far into the future. Asset values are affected by certain factors, particularly stock market performance.
- Market volatility, increasing life expectancy and escalating costs have seen private corporate DB schemes disappear as the main form of occupational scheme in the UK.
Defined contribution schemes (DC or money-purchase schemes)
- DC schemes place the risk of underfunding on the employee.
- Employees are usually expected to select their own investment strategy for the scheme.
- Most schemes offer a default which most employees invest in.
- At retirement, the pension fund can be used to provide a lump sum and/or income (see Taking a pension).
- The size of the pension fund will depend on how investments have performed.
Hybrids/Risk Sharing Schemes
- These are neither pure DB nor pure DC and allow for risk sharing between employer and employee.
- Hybrid schemes include career-average plans and cash balance plans.
- Seen as a compromise between DB and DC, hybrids are gaining a place in occupational pension provision but remain the exception rather than the norm.
4. The run up to retirement
Employees can no longer be retired unless there is a fair reason for dismissal
- For example, capability or conduct.
- Alternatively, the employer may force retirement if it can be 'objectively justified', but in most situations this is unlikely.
Provide employees with a pensions forecast
- Your pension provider should be able to provide a reliable forecast of the employee's pension.
- Employees can get an estimate of their state pension from the Future Pension Centre.
Offer your employees independent financial advice
- Pensions advice worth £150 a year can be offered as a tax-free benefit to employees. However, if the cost exceeds £150, the whole amount will be taxed.
- Employees with a defined contribution pension can get free and impartial guidance on pension choices at retirement through Pension Wise.
Taking a pension
There have been significant changes to the rules for defined contribution pension schemes:
- Individuals are allowed a tax-free standard lifetime allowance (SLA) of £1 million.
- The total value in all registered schemes will be tested at the time benefits are taken or at age 75. Any excess above the SLA will be subject to a charge of 25% if used to increase pension payments or 55% if taken as a lump sum.
- Benefits may be drawn after age 55. You do not have to retire or leave service to take pension benefits.
- You can take a tax-free lump sum of up to 25% of the fund. You can withdraw larger sums but income tax is payable on any excess.
- You can still choose to buy an annuity to provide a regular income but are not required to do so. The level of annuity income depends on prevailing interest rates.
- You can also invest in a 'flexi-access drawdown' fund. This leaves your savings invested and allows you to draw a more flexible income, but without a guaranteed lifetime income.
- Savings left in your pension fund when you die can be passed on in your will.
- Pension fund members should take advice and shop around to find the best option.
- Get more information on employers' pension obligations from the Pensions Regulator (0345 600 1011).
- Check your staging date through the Pensions Regulator.
- Find out more about the NEST workplace pension scheme.
- Find guidance on checking an existing pension scheme to see whether it meets the automatic enrolment rules from the Pensions Regulator.
- Find an independent financial adviser for your business through unbiased.co.uk.
- Check a financial adviser's authorisation by searching the Financial Services Register.
- Help employees get an estimate of their state pension from the Future Pension Centre.
- Help employees get free guidance on pensions from the Pensions Advisory Service (0300 123 1047) and on taking a defined contribution pension from Pension Wise (0800 138 3944).
- Find guidance on running a pension scheme from HM Revenue & Customs.
Employment law is complex and is changing rapidly. This factsheet reflects our understanding of the basic legal position as known at the last update. Obtain legal advice on your own specific circumstances and check whether any relevant rules have changed.
"Many employees want to save for their retirement but are put off because they are not sure where to go to gain more information." - Frances Corbett, Project manager, PENSIONSFORCE