July 19, 2016
Happy with auto-enrolment? Maybe it’s time to re-evaluate your budget
The auto-enrolment pension scheme is a political solution to a long-term problem – the continuous growth in our life expectancy, and how we’re going to pay for it. But what’s happening in the short-term, and what does it mean for business and employees?
The UK’s decision to leave the EU, David Cameron’s shock resignation immediately following the results, and new Prime Minister Theresa May’s sweeping changes to the Cabinet mean nothing is now certain in terms of Government policy.
We may still see an early general election, as opponents call for Theresa May to go to the country for a mandate. But even without one, the new team in the Cabinet Office will be keen to make their own mark.
New Chancellor of the Exchequer Philip Hammond has already announced he’ll be scrapping plans to implement George Osbourne’s austerity budget.
One (of many) questions on the minds of SMEs right now is pensions, specifically:
Will he be making changes to the auto-enrolment pension scheme before the planned increase to contributions in April 2018?
Auto-enrolment: the background
Auto-enrolment into a Workplace pension scheme began in October 2012, with new rules making it compulsory for employers to automatically enrol their eligible workers into a pension scheme – with employers also obliged to pay money into the scheme in most instances.
The Government is phasing in the system between 2012 and 2018, with the largest employers in the UK being the first to have to comply with the new system. All employers, regardless of size, must comply with the scheme by 1 February 2018.
If you were one of those who had to enrol employees in the early years of the scheme, you’ll know that the minimum contribution for employers during the first five years was one percent of an employee’s eligible earnings, with your employees contributing the same percentage.
Back in 2012, the date for the first scheduled increase in contributions – October 2017 – was such a blissfully long way away it wasn’t worth worrying about. But that scheduled increase in your contributions isn’t outside the scope of your five year business plan any more – it’s just around the corner, and it’s time to plan for it within your budget.
If you haven’t already done so, now is the time to re-evaluate the effect the increase in pension contributions will have on your costs, as well as your employees’ pay packets.
If you’ve read this far and are still blissfully ignorant, then let me give you some background.
Why do we need auto-enrolment?
People are living a lot longer these days.
If we take into account the way life expectancy has increased over the last few generations, the first person to live to 120 is already drawing their pension and the first person to live to the age of 200 (!) has just been born.
That’s a long time to live without adequate income if you plan on retiring at State Pension age.
And the ratio of working people to pensioners is also on the increase.
In 1950, there were seven people working for every person of pension age. Currently, there are just four people of working age for everyone drawing a State pension.
By 2050, that ratio is expected to be just two working people to every person drawing a pension.
Remember: current State Pensions are paid from the contributions of today’s workers!
So what’s the solution?
To ensure people save sufficiently for their retirement, the Government decided to intervene.
In 2012 the Work Place Pensions Reform scheme came into effect, which included phasing in auto-enrolment into a pension scheme for all employees, beginning with the largest employers.
Four years on, we are entering the final phase of enrolment: for small to micro employers, who have until April 2017 to comply.
How does it work?
When the scheme was introduced in 2012, minimum pension contribution rates were set at one percent for employers and employees. This meant employees had to contribute a minimum of one per cent of their eligible earnings to a pension scheme, and their employer had to contribute the same amount on their behalf in most instances.
In 2015, the now ex-chancellor, George Osborne, postponed a planned increase in contributions from October 2017 to April 2018.
Now, from April 2018, the employers’ contribution will double to two percent of eligible earnings, with the contribution by employees tripling to three per cent.
A second increase in April 2019 will see the employer minimum contribution increase to three per cent of eligible earnings, with the employee minimum contribution increasing to five per cent (excluding any eligible tax relief). Ouch!
What’s it going to cost?
Here’s a breakdown of income and costs for an employee on a salary of £18,000 with an 1100L tax code:
- Eligible pay of £1,500 for the month in March 2018
- 1% pension contribution of £15
- Less tax relief at 20%
- Employee net contribution of £12
- Employer contribution of £15
Following the increase in April 2018:
- Eligible pay of £1,500 for the month in April 2018
- 3% pension contribution of £45
- Less tax relief at 20%
- Employee net contribution of £36
- Employer contribution £30
This equates to £24 a month less in net pay in April 2018 than in March 2018 pay, assuming salary and tax codes remain unchanged.
What will happen next?
We can’t say for sure, because we don’t know what changes will be made in future Government budgets.
But we can make some predictions using current circumstances:
1. Employees may begin to cease contributions to the scheme if they perceive this as being too costly – a three-fold increase in April 2018. Funds would then stay in the scheme until retirement unless the employee was auto-enrolled for less than one month. In this case, the employee would receive a refund of any contributions.
2. More employees may choose to opt out when they start work with an employer.
3. Those who opted out at the staging date may elect to stay out at the end of the three year re-enrolment period.
4. There may be a reduction in the number of people who aren’t eligible for compulsory enrolment but decide to opt-in anyway.
5. Employers will still need to provide an auto-enrolment pension scheme no matter what the workforce elects to do.
In summary: rather than encouraging people to pay into a pension scheme we may in fact see the opposite effect, with more people opting out when they see the costs involved. Perhaps a voluntary approach to increases rather than imposing mandatory ones may have been the better approach?
But there is still time for this to change and, as former Prime Minister Harold Wilson said back in the 1960’s:
“A week is a long time in politics.”
These days you can replace ‘week’ with ‘day’ and you’ll be closer to the truth of it.
So, while things are far from certain you need to be aware of the changes as they stand and make sure you plan for them in your own budget.
And if things do not change in terms of the planned increase in contributions, make a note in your diary for April 2018 to publicise the increase to your Workforce.