January 29, 2019
As employers prepare for the second phase of contribution increases, First Actuarial’s Simon Redfern gives auto-enrolment a health check and looks ahead to future enhancements
The introduction of pension auto-enrolment (AE) in 2012 marked a recognition that as a nation we are failing to save enough for retirement. The harsh reality is that without raising taxes, the state is unable to provide us with the income needed to pay for the lifestyle choices we aspire to in our retirement. The quality of life we enjoy (or suffer) in later years largely comes down to the choices we make as individuals.
AE was based on the assumption that if people didn’t bother to join a pension scheme, if they were entered into one they would similarly not bother to leave. To ease people (and employers) into the pensions mindset, minimum contributions were set at a low level, with planned increments over time, and people had the right to opt out.
It seems to be working.
With not long to go before the second phase of contribution increases in April 2019, now seems as useful a point as any to review AE, go through any challenges that remain, then look ahead to see what further changes are in the pipeline.
April 2019 – The second AE contribution increase
As I’ve said, contributions were low when AE first came in. We’ve gone through one phasing event – an industry term for the point at which contribution increases and limit changes take effect – and the second one is due in April 2019. Finance, payroll and HR professionals may be relieved to know that there are no further phasing events announced.
This table below shows how each minimum pay basis will increase this April:
|Current||From 6 April 2019|
|Minimum compliant rates||Qualifying Earnings||2%||5%||3%||8%|
|Set 2||Basic *||2%||5%||3%||8%|
* where basic salaries must, in aggregate, be at least 85% of gross earnings.
The Government has committed to maintaining the AE earning trigger at £10,000 for the 2019/20 tax year (in practice this is calculated per pay period). It has also confirmed that the lower and upper qualifying earnings limits will increase to £6,136 and £50,000 respectively from April 2019.
We go through this in more detail in our freely available First briefing.
The changes are being introduced with effect from the start of the new tax year, so the impact on people’s payslips will so be partly offset by a number of changes – the new income tax personal allowance and bandings, National Insurance (NI) rates and increases in the National Minimum Wage and the National Living Wage.
How should you communicate these changes to your employees? While there’s no legal requirement to do so, bearing in mind that the changes may well reduce take-home pay, it might be a good idea to remind employees that this will be happening. They will then be more prepared for the change and are less likely to bombard your HR or payroll team with queries or complaints.
Mind the gap – the net pay trap
One issue that may affect some of your employers is what is known as the net pay trap. While the earnings trigger is not changing from £10,000, as I’ve said, the income tax personal allowance is due to rise in April 2019 from £11,850 to £12,500. This means that there’s a widening band between the point at which people are being auto-enrolled, and the point at which they start paying tax.
The risk is that people earning between £10,000 and £12,500 p.a. will end up in the wrong type of pension scheme when they’re auto-enrolled. In those occupational pension schemes established as ‘net pay arrangements’, members don’t qualify for any tax relief on their personal contributions as no tax is paid on their earnings. On the other hand, in a ‘relief at source’ arrangement (generally ‘contract-based’ arrangements, but also certain occupational schemes, including NEST), they get 25% tax relief top up on their own contributions, despite not paying tax.
It may be the case, then, that employers have established pension schemes which are inadvertently tax-inefficient for certain employees. And as a result, some lower paid employees don’t get the pension benefits they’re entitled to, while higher earning employees others receive full tax benefits.
I believe it’s important to ensure that your hard-working employees receive pension benefits in the most tax-efficient way possible.
The Pensions Regulator (TPR) is aware of the problem and believes that employers should consider the impact of this on their workforce and where appropriate, consider making alternative arrangements for those employees affected
Are you doing AE right?
One linked issue that is starting to get some attention is whether employers are deducting the contributions correctly from employees’ salaries –from either their gross or net salary, according to the basis on which their scheme has been established. If this is done incorrectly then employees will either get no tax relief or double tax relief – either way there is clear potential for problems.
This has been acknowledged by both TPR and HMRC who issued a joint statement on the matter in 2018.
It’s really important that employers check that they’re doing everything correctly – we can help you resolve that problem, but it does involve a fair bit of unpicking.
Using salary sacrifice to offset increased contributions
One way to offset the increase in AE contributions is to use salary sacrifice, or salary exchange as it’s also known, to make NI savings. Implementing salary sacrifice as these contribution increases take effect can reduce the impact on take-home pay for employees, and lower the financial burden of increased contributions on employers.
So how does this work? Under salary sacrifice, an employee opts to reduce their gross salary by an amount equal to their desired pension contribution. In return, the employer agrees to pay into the pension scheme an amount that is equivalent to the gross amount of salary the employee has exchanged. Employer and employee NI are payable on gross salary, but not on employer pension contributions.
This is how salary sacrifice generates NI savings for both employer and employees. Not only that, but employees see an increase in their take-home pay. The total amount of money paid into the employee’s pension fund remains the same, and total pension benefits are unaffected.
In my experience salary sacrifice is becoming increasingly common. When we raise it with our clients, there is usually some awareness of it. Some may be using it unknowingly in areas such as childcare vouchers. Others find it offputting, maybe too complicated, although I always explain that it needn’t be so. It’s really just a slightly different way of making pension contributions.
If a company is going through changes to their pension scheme(s), the cost of introducing salary sacrifice is usually quite small. But it can also be implemented as a standalone project as a way of softening the blow of contribution increases from AE or as a result of pension scheme valuations. It’s a great way of making pension arrangements as cost-efficient as possible.
One point to note is that salary sacrifice is not suitable for everybody. For lower earners, salary sacrifice doesn’t work. And you need to take extra care when AE overlaps with state benefits.
While the Government isn’t championing it as such, they are accepting of it. HMRC will want to see that you’ve set it up correctly though. If you haven’t, they can and will make you undo it all and sort it out, which is expensive and time-consuming.
We provide more detail on all of this in our First briefing on salary sacrifice, and we can help introduce it in your organisation.
What further AE changes are on the horizon?
It’s clear that AE is here to stay. Having gone through the first phasing event in 2018, we’ve seen that the number of people leaving their pension scheme as a result of higher contributions was insignificant. These days businesses of every size need to comply – in contrast to the early days when AE applied only to larger companies, the Tescos of this world.
Most employers are managing AE perfectly well, with only minor difficulties in some cases. The Pensions Regulator is reluctant to adopt a big stick approach if it’s clear that the employer is trying to do the right thing.
So rather than questioning the viability of AE, the attention is much more on how to develop it further.
A policy paper from the Department of Work and Pensions (DWP), Automatic enrolment review 2017, was subtitled ‘Maintaining the momentum’, another clear indication that AE is here to stay.
The paper made a number of recommendations, including:
- Ensuring that workers on all levels of income are included
- Extending AE to the self-employed
- Reducing the lower age limit from 22 to 18
- Starting pensions from the first pound of earnings rather than the minimum level, which is around £6,000 p.a.
I believe these changes would be very positive ones. With an extension to all workers, everyone would be entitled to minimum employer contributions should they decide to opt in. Reducing the minimum age would get people saving into pensions at an earlier stage. The self-employed certainly need to consider how they will provide for their retirement, not least because they don’t have the same entitlement to state benefits. There has been talk of an additional, almost compulsory, NI contribution, which is a good idea in principle and worth looking at.
While such measures can only be a good thing, however, I do think that in the longer term the minimum total contributions need to increase beyond the current level, and I also wonder whether there should be a more equal split between members and employers. The minimum contributions are currently tilted so that employees pay more than their employer, and maybe that needs to shift.
As the situation stands, the Government has taken the recommendations on board and are looking to introduce them in the mid-2020s. If you consider that the Government has Brexit to contend with, however, you might find that aspiration less reassuring.
In the meantime, new businesses have to set up AE immediately, and after April contribution rates will be stable. So leaving aside minor tweaks such as increases in line with inflation, the policy paper recommendations will be the next opportunity to include those who are currently missing out.
Engaging with your employees
The immediate challenge is to improve engagement. To achieve the current retirement income that people want, they need to save more than those minimum levels. So there needs to be a realistic conversation with people – it’s great that you’re in a pension scheme, but how much is this going to provide you with once you’ve retired?
It’s problematic because, of course, so many lower earners are buckling under the weight of competing financial pressures. If you’re struggling to keep a roof over your head, put food on the table and keep on top of bills, how important is saving for something that’s decades away?
On balance though, I think that AE is meeting its original objectives. It’s got more people into pension schemes, and reports from organisations like TPR confirm that there’s an enormous number of people saving into pensions who weren’t doing so before.
In only seven years, we’ve made a great start.