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Band out of tune

The Government says it will allow employers to self-certify that their pension schemes are good enough to exempt them from running personal accounts.

Pensions minister Rosie Winterton claims the move is aimed at lessening the burden for employers but pension commentators believe the Government has not gone far enough and predict that employers may still opt to level down or close their pension schemes when faced with having to prove their schemes are good enough to run against personal accounts.

Aegon head of pensions development Rachel Vahey says the Government could jeopardise good pension schemes if it does not tackle the way that earnings are calculated. She says: “I think the amendment is a step in the right direction but we are by no means at the end of the journey. The question is how useful this is going to be in practice.

“The employers running these schemes are the good guys and if you disturb them, then that is not achieving our outcome. The Government should be focusing on those people who are not saving into a pension at all.”

The issue arises because the Pensions Bill states that gross minimum contributions of 8 per cent of banded earnings are paid into a pension.

Banded earnings are earnings between £5,035 and £33,540 in 2006/07 terms. Employers have to pay in at least 3 per cent of the total. These earnings take into account all bonuses, overtime and commission.

But most private sector pension schemes use basic earnings to calculate pension contributions. If employers want to stick to this definition of earnings, then they must check that the percentage of basic earnings is greater than or equal to 8 per cent of band earnings.

If the contribution from basic earnings is less than the contribution from band earnings, then employers and employees must make up the shortfall.

The self-certification process which the Government has introduced will allow employees to continue using basic earnings if they certify once a year that they expect their employees to receive contributions in line with the banded earnings’ definition.

But this will still result in a five-stage administration process, which Standard Life head of pensions policy John Lawson believes will push the majority of employers towards using band earnings instead.

The upshot is that many lower-income employees receive lower pension contributions under a band earnings’ scheme than if basic earnings were taken into account.

For example, someone on a minimum wage of £10,500 and bonus of £2,000 will get a pension contribution of £840 a year if calculated using basic pay. But, based on 8 per cent of band pay, they will only get £597 a year.

It will hit low-earners hard – the people that personal accounts are designed to help. Conversely, it is good news for high-earners. An employee earning £50,000 with a £10,000 bonus will get £4,000 a year using basic pay but £4,397 using band pay.

The pension industry has been lobbying the Government to base personal accounts on basic earnings in line with the method currently used in the corporate pension market.

Although self-certification is a very small step forward in the battle, Lawson believes it is a waste of time.

He says: “I do not think it is going to be of great use because employers will still have to go through a lengthy process. It is a bit of an administrative nightmare.

“There is no doubt that schemes will switch to band earnings, which is bad news for low-earners. It is a waste of time and it is pointless even creating this legislation. The Government is wasting our time and their time.”

The Association of British Insurers says it supports the principle of employer self-certification but has concerns that the amendment may not reduce the admin burden on firms.

ABI director of life and savings Maggie Craig says: “The current drafting of the amendment adds considerably to the administrative burden for employers and risks discouraging them from continuing to provide pensions to their employees that have higher contributions than the level set for personal accounts.

“We sincerely hope that this issue can be resolved and we will continue to work with the Government on the details of their proposals to ensure that the interests of pension savers and employers are properly protected and these reforms fully achieve their objectives.”

Hargreaves Lansdown head of pensions research Tom McPhail says he does not think the amendment will be enough to prevent employers from switching to band earnings.

He considers it could still lead to some employers deciding to stop running their group personal pensions in favour of starting a personal account due to the admin burden.

He says: “The Government should keep it simple and just calculate it on basic earnings. Even with the amendment, it is still going to mean tedious and complicated calculations to check that it complies with the legislation. I am not sure they have really solved the problem.”

Vahey says it is difficult to predict exactly how employers will react to this legislation as there is still so much more regulation to be decided over the coming years but she stresses that if the contribution basis stays as it is, a lot of people will lose out.

She adds: “We are looking for the route of least disturbance. Not having the amendment would have been much more damaging. Now we have to figure out how to put it to practical use.

“The Government must centre its decisions on how to make it as easy as possible for employers to run their existing pension schemes because, if they don’t, employers will level down and it will be the employees who will lose out.”

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