The legislation is concerned with making sure all employers pay pension contributions for their workforce. The problem is that the Government has designed the legislation around the idea that employers will be paying into the new personal accounts scheme. This ignores in one fell swoop the fact that thousands of employers are already paying pension contributions into existing pension schemes and helping them save for retirement.
Employers offering money-purchase schemes, whether occupational or contract-based, look like they will have to think about the way they currently offer pension schemes and work backwards to compare this with the way that the Government wants personal accounts to work. This is not the right starting place if one of the main objectives is to maintain and, if possible, extend the current pension provision.
The minimum level of contributions is one issue that has brought the Government’s approach into very sharp focus. It makes perfect sense that those automatically enrolled into private money-purchase pension schemes should get at least the same level of contributions as those who are automatically enrolled into personal accounts.
The problem is that the majority of private pension schemes base contributions on all basic earnings while personal accounts base contributions on a band of near-gross earnings. So the Government is asking existing private pension schemes to either introduce significant administration workarounds to check their contributions are at least the same or, to avoid that check, completely change the way that they pay contributions, with the work that involves for members, employers and any trustees.
The implications of this could be enormous. Over five million people save for their retirement in defined-contribution arrangements, either trust or contract-based. To impose this standard on existing schemes flies in the face of the Government’s stated aim that personal accounts should complement the existing market. The risk is that employers will compensate for these changes by levelling down pension contributions or restricting access to their pension schemes.
Moving to the personal accounts contribution definition based on a band of earnings will hit lower-paid employees, for whom the first £5,035 is a greater proportion of their total earnings, the worst. Women will be especially affected. Their remuneration is less likely to feature large elements of overtime, commission or bonus, meaning they will get lower contributions and, therefore, a lower retirement income.
A chink of light now lies in the Government asking for alternative solutions to how to make this work in practice while keeping its basic principle that an individual should get a minimum contribution. The ABI, together with the NAPF, has put forward a couple of solutions.
The first surrounds the timing of the test of the private pension scheme contribution against the personal accounts minimum. The Government originally envisaged that this should happen every time a payment is made. But there will be schemes for whom a yearly test would be better as they may fail some months but pass all the other months by some considerable margin. Giving schemes the option of testing on a yearly basis will mean significantly fewer schemes failing the test.
The other solution is to allow those “good” schemes, who currently have a substantial pension contribution, to continue under the new regime. This grandfathering approach means that if the scheme pays at least 8 per cent of basic earnings, it will be allowed to continue to do that for all members (whether existing or new).
Obviously, there will have to be some form of regular check to make sure members are not losing out but this should remove some of the admin pain.
We need to find a solution to this dilemma. By striving for perfection, we place too many admin hurdles in the way of employers and they give up on their existing provision. The losers will be the workforce, who will find their pension provision swapped for often a much lower contribution rate and consequently a lower income in retirement.
Rachel Vahey is head of pen-sions development at Aegon