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Band aid

The definition of basic earnings poses a tough problem

Certification of pension schemes that use basic pay to calculate contributions is a difficult nut to crack.

Ever since automatic enrolment band earnings were proposed, the industry has argued existing good quality pension schemes should be able to ignore band earnings if they paid contributions equivalent to or above this level.

The DWP’s Making Automatic Enrolment Work review last September recommended existing schemes could certify if they met one of three criteria – contributions were at least 7 per cent of pensionable pay and all pay was pensionable, or, 8 per cent of pensionable pay where 85 per cent of pay was pensionable, or, 9 per cent of pensionable pay with at least 4 per cent from the employer.

Legislation to implement the recommendations has recently been made available for consultation and contained a bit of a surprise. Instead of pensionable pay, there is “basic earnings”. The definition of basic earnings includes all regular pay items, including bonus, overtime and commission.

But employers do not include pay items such as bonus, overtime and commission in what they call basic pay or pensionable pay. In fact, this new definition looks similar to the one used for band earnings.

This begs an obvious question: “Why pay 9 per cent of total pay, including bonus commission and overtime, when I can get away with paying 8 per cent of a similar amount and also ignore the first £5,715 of each employee’s earnings?”

Employers are very unlikely to change their current definition of pensionable pay to the new basic earnings definition. After all, that would mean making a slice of pay pensionable when it currently is not. Already faced with a cost increase from enrolling non-joiners, employers will not be falling over themselves to increase their contributions for all staff.

If the 9 per cent option looks to be unworkable, what about the other two options.

The 7 per cent option says you must pay 7 per cent of total pay, including all pay items such as bonus, commission and overtime. As this rate is lower than the rate applying to band earnings, this seems fair. But it is also a mathematical no-brainer – 7 per cent of total pay is always more than 8 per cent of band earnings, all the time and for all employees. If this is a cast-iron mathematic certainty, why is there a need to certify 7 per cent of total pay at all?

The final option is 8 per cent of basic earnings (same definition as above) where basic earnings are at least 85 per cent of total earnings across the workforce. This option does appear to have some use. Although 8 per cent of 85 per cent of total pay is also always greater than or equal to 8 per cent of band earnings, the test applies across the whole workforce. So there may be employees who pass this test on an individual basis and some who fail but, overall, the scheme can still pass.

Maybe this 8 per cent definition should also be used for the 9 per cent and above contribution as long as basic earnings are at least, say, 75 per cent of total earnings.

Formal consultation will take place over the summer, so certification is not yet lost but there are no easy answers to this conundrum.

John Lawson is head of pensions policy at Standard Life

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