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Madness in the method

The latest Pensions Bill will become law during the autumn Parliamentary session. This makes it the fifth Pensions Act in 10 years. It follows the recommendations of the Pensions Commission in requiring employers to enrol their employees in a pension scheme. This can include a personal account.

Many still argue – and it is a fair argument – that the correct policy response is a higher state pension but the Government will press on with its plans regardless. It is highly unlikely that the Tories or LibDems would do anything different, having given this legislation their tacit support.

The bill also has the unequivocal support of Which? and the Trade Unions Congress – not surprising given that the bill compels employers to pay 3 per cent of banded earnings into the pensions of employees who do not opt out. What is surprising is the support that they have given to the method of calculating contributions.

Readers will be aware that the definition of earnings enshrined in the bill is causing existing schemes, trustees and sponsoring employers considerable angst. Most existing schemes use basic earnings to calculate pension contributions from the first £1 of earnings. The bill includes elements such as overtime, bonus and commission. It also uses a band of earnings (roughly £5,000 to £33,500 in 2006/07 terms).

While the Government insists that schemes can still use basic earnings, contributions must meet the statutory minimum. Schemes therefore need to perform an annual check to determine whether X per cent of basic pay is greater than 8 per cent of banded total earnings. If it is not, the employer must make good the difference.

The only cast-iron way to ensure they do not fail the test is to mimic the definition of banded earnings included in the bill but this means including bonuses, overtime and commission which will lead to higher contributions. Employers are therefore very likely to temper this increase by also moving to banded earnings. This will result in lower contributions and that is why the Confederation of British Industry, the Association of British Insurers and the National Association of Pension Funds have argued so vociferously against the bill’s definition. Employees’ and providers’ interests are completely aligned.

The TUC and Which? are effectively arguing for lower contributions. They say that allowing some form of basic earnings’ test could result in some employees receiving lower contributions than those set out in the bill.

Their argument may be well intentioned but in seeking absolute protection for the rights of a handful of employees, they may have unwittingly condemned untold members to a poorer retirement. That would be a great pity.

John Lawson is head of pensions policy at Standard Life

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