The Road to 2012: Final Preparations Underway

Introduction

With the launch1 of yet another consultation on workplace pension reforms, the 2012 starting line for automatic enrolment draws one step nearer.

This latest consultation follows the findings of an independent review published in October 2010, “Making Auto-Enrolment Work“2 (the Review). As well as bringing into effect the remaining recommendations from the Review, it also seeks to iron out the finer (and hopefully final) points of automatic enrolment.

Key points

Automatic enrolment remains on track to start in October 2012, but with the largest employers3 able to begin automatic enrolment early, from July 2012.
In a bid to manage the burdens on business, employers will be able to apply a waiting period of up to three months before the automatic enrolment duty applies.
Regulations will prescribe the certification requirements for DC schemes to demonstrate that they are qualifying schemes for automatic enrolment purposes.

Background

Starting in 2012, employers will be required to enrol their “eligible jobholders” into a qualifying pension scheme. Eligible jobholders are workers between the ages of 22 and State Pension Age who earn more than £7,475.4 Once enrolled, eligible jobholders will have a period of time during which they can opt-out of membership.

The new auto-enrolment duty will come into force in stages from October 2012, starting with larger employers first5 . Employers will be able to choose to enrol eligible jobholders into their own designated “qualifying scheme” or use the Government established pension scheme, NEST.

Qualifying schemes

Just as athletes the world over are attempting to meet Olympic qualifying standards, pension schemes also need to qualify if they are to be used for automatic enrolment purposes.

A qualifying scheme can either be an occupational pension scheme or a personal pension scheme and must normally be a registered pension scheme under the Finance Act 2004. It must also satisfy certain quality requirements, which vary depending on whether the scheme is a DB or a DC arrangement.

The DB test

A DB scheme will meet the quality test if it is contracted-out on the reference scheme test basis6 or if it is broadly equivalent to, or better than, the “test scheme standard”. The test scheme standard is based on a pension payable from age 65, equal to 1/120th of average “qualifying earnings”7 in the last three tax years before the end of pensionable service for each year of pensionable service (subject to a maximum of 40 years). This standard also assumes that the pension is revalued in deferment and increased in payment in line with the increase in CPI (subject to a maximum of 2.5% per annum).

The DC test

The quality test for a DC arrangement is based on the contributions made to that arrangement. By the end of the transitional period (in October 2017), contributions payable in respect of the jobholder must be at least 8% of qualifying earnings overall, with 3% from the employer, 4% from the jobholder and around 1% in tax relief.

A key recommendation in the Review was to make the certification process for DC arrangements more straightforward. Designed as an administrative easement for employers who calculate their pension contributions from the first pound (rather than on qualifying earnings), the proposals will allow schemes to self-certify if:

a minimum contribution of 9% of pensionable earnings is paid to the scheme for each jobholder (including at least a 4% employer contribution);
a minimum contribution of 8% of pensionable earnings is paid (with at least a 3% employer contribution), provided that total pensionable earnings of all relevant jobholders in aggregate constitute at least 85% of their total earnings; or
a minimum contribution of 7% of total earnings is paid (with at least a 3% employer contribution) – this requires 100% of earnings to be pensionable.

“Pensionable earnings” here means whichever is the higher of the employer’s definition of pensionable earnings or basic pay, from the first pound.

Draft guidance for employers and their advisers also forms part of the consultation, setting out how employers can use certification “as a means of ensuring that their money purchase and/or hybrid scheme can qualify to be used for automatic enrolment and related duties”.

Is the finishing line in sight?

As well as changes to certification, the consultation proposes amendments to various existing and draft regulations, including:

the introduction of an optional waiting period before an individual needs to be automatically enrolled (jobholders will still be able to opt in during this period, although there will be no obligation on the employer to contribute);
delaying the automatic enrolment staging date for the test group of “micro” employers8, in line with the current moratorium on regulation for small businesses which was announced in the 2011 Budget;
the application of CPI as the relevant measure of increases to pensions in payment and deferment for qualifying schemes, in line with the switch from RPI for both public and private sector schemes; and
greater flexibility around the requirement to automatically re-enrol jobholders who have opted-out, so that employers are required to carry out the re-enrolment exercise three years after the employer’s staging date (i.e. the date when the automatic enrolment duty first applies) or the previous re-enrolment date, with the option to choose a re-enrolment date up to three months on either side of the three year anniversary.

What next?

The consultation closes on 22 October 2011, after which the draft regulations and guidance will be finalised.

Employers, particularly those in the early staging groups, should consider taking action now to ensure they get out of the starting blocks on time.

1 On 19 July 2011
2 Please see our Alert: “NEST comes home to roost!” dated 28 October 2010
3 Broadly those with >50,000 employees
4 In 2011/12 earnings terms – the actual figures that employers will need to use will be announced around January 2012
5 Determined on the basis of an employer’s PAYE reference and using an employer’s PAYE scheme size as an indicator of employer size
6 Broadly, for a scheme to satisfy the reference scheme test basis at least 90% of members must have benefits equal to or better than a “reference scheme”. The reference scheme is a notional scheme which provides a pension of 1/80th of qualifying earnings for each year of service and also provides a 50% dependant’s pension on death of the member
7 Gross annual “earnings” between £5,035 and £33,540 in 2006/7 earnings terms. These figures will be uprated for 2012 and are due to be announced early next year
8 Those with fewer than 10 full-time equivalent employees immediately before 1 April 2011 but who are part of a multiple employer PAYE scheme with more than 239 persons within that scheme