Having seen a pensions crisis looming on the horizon, the UK Government has taken big steps to ensure today’s workers save for their retirement. Jim Banks speaks to Bill Galvin, chief executive of The Pensions Regulator, about how employers and employees alike should prepare for automatic enrolment.
It has long been known that the provision of pensions after retirement will become a growing burden on taxpayers as the UK population ages. However, after many years of discussing the impending problem, the talk today is of the introduction of what the UK Government hopes will be the solution.
From October this year it has become compulsory for employers with more than 50,000 staff to offer their employees a company pension scheme. From 2013, employers with more than 500 staff will also be obliged to make the same offer, and within the next four years the same rules will apply to even the smallest businesses.
Put simply, companies will be required to automatically enrol eligible employees into a qualifying workplace pension and to make a minimum contribution. The expectation, according to estimates from the Department for Work and Pensions (DWP), is that auto-enrolment will almost double retirees' income by the time today's young people become pensioners. The DWP expects that under auto-enrolment the average weekly income from a private pension will be £153-195 by 2070, compared with £86-106 without the scheme.
These estimates are based on the new scheme's requirement to put a minimum of 8% of a worker's salary into a pension scheme each month, with the employer contributing a minimum of 3%. The resulting pension pot will also be subject to tax relief.
"Auto-enrolment has been brought in because individuals are not saving enough for their retirement," explains Bill Galvin, CEO of The Pensions Regulator. "The problem is inertia. People simply don't get around to it. Auto-enrolment turns that on its head. Now, you have to act if you don't want to be in a pension scheme."
"It is driven by the fact that the coverage of pension providers in the workplace has dropped in recent years and there has been a shift from defined benefit to defined contribution schemes. This has seen contributions fall. So, the government's regulations are designed to increase coverage. If you put 8% of your income away you won't be rich, but it is better provision than if you save nothing at all."
The Pensions Regulator oversees the UK's work-based pension schemes and has clear objectives set out in the Pensions Acts of 2004 and 2008: to protect the benefits of members of work-based pension schemes; to promote and improve understanding of, and the good administration of, such schemes; to reduce the risk of situations arising that may lead to compensation being payable from the Pension Protection Fund (PPF); and to maximise employer compliance with employer duties.
"We are focussed on raising awareness and we have been communicating with all of the 1.2 million employers that need to do this. 94% say they know they need to do something, so we have been successful, but many of them underestimate the challenges. We have also been preparing the industry so that pension providers will be ready with products."
Workplace pensions choices and obligations
In the years ahead, employers will have no choice about whether to offer workplace pensions to their staff. Obligations are not always met with enthusiasm, but auto-enrolment has been widely embraced by the corporate and political communities.
"Almost 60% of employers of all sizes support the principle of auto-enrolment. They see it as the right thing to do, so we are swimming with the tide despite the changes in the economic environment. There is also support across political parties," says Galvin.
By the end of 2013, some 5,500 large employers with a total of 17 million employees will be required to move to auto-enrolment. These companies will be able to engage specialised consultants, but as the scheme then comes into force for small and medium-sized employers it is likely that products will be bought off the shelf, and that accountants and IFAs will be required to consult with their clients on auto-enrolment.
"Their workforces may be less complex, but they need to do the same assessments," says Galvin. "They need to follow our seven-step template and address all the detail that lies beneath it. We have some simple tools on our website to help companies and to educate their IFAs and accountants."
For smaller companies there are questions about whether the pensions industry will provide appropriate products. That is why the government has set up the National Employment Savings Trust (NEST) as a qualifying workplace scheme that's available to companies of any size, particularly those without an existing scheme, and the self-employed. Employees earning more than £7,475 a year will be automatically enrolled in NEST if their company has no pensions scheme. Lower earners can also opt in.
"NEST is the pensions scheme set up by the government because of the failure of the market," explains Galvin. "Although there are private sector pensions providers, the smaller, less rich companies were not attractive to them. NEST has to take any employer who knocks on the door, so it is ideal for low to medium earners. It is regulated like other pension schemes and employers' duties are the same, so if no other private pensions provider will take you then NEST will."
Along with the obligation on employers to provide a pensions scheme there is also an element of choice for employees. The default position will be auto-enrolment, but workers can choose to opt out. As Galvin says, the role of inertia has been changed, so that employees must now act if they do not want to be part of a scheme.
Preparing for auto-enrolment
It must be understood that auto-enrolment is a big change, and also that The Pensions Regulator has powers to impose penalties on companies that do not comply.
"Not only is auto-enrolment the right thing to so, it is the law," says Galvin.
The onus, therefore, is on CEOs and CFOs to prepare for auto-enrolment. There is plenty of information and support available, so they should start their preparations as soon as possible.
"Employers underestimate the preparation that is required to deliver auto-enrolment to the workforce," says Galvin. "For large companies it is an 18-month process and it requires effective communication. Many large companies think it will take three months and our surveys suggest that 50% of employers say it will be done at the last minute, largely because it is not happening in a vacuum and they have other things to consider. But it needs a systems change, so they need to leave plenty of time. Payroll technology, for example, needs to be ready for auto-enrolment."
He continues: "The DWP has a programme of communications to let individuals know what is coming, so individuals know that they will be auto-enrolled. So CEOs have a bedrock of information on which to build. The government wants to communicate to everyone that auto-enrolment is in everyone's best interests so that people understand the small deductions from their salary when they start.
"But companies must have their own communications strategy, including letting people know that they can opt out. The challenge is to get employers to give out the message about the importance of saving for retirement."
As the scheme is introduced over the coming years, every CEO will get a letter from Galvin as part of the Pensions Regulator's auto-enrolment education strategy. The CEO will then have the responsibility of ensuring the message is communicated to all employees. Equally, CFOs have an important role to play.
"They must ask the right questions of their pensions providers and software vendors. They also need to engage fully with the workforce and be clear about what will happen, when and why. It also helps us if we have a single point of contact for interaction, help and support with auto-enrolment, and that may well be the finance director," says Galvin.
Auto-enrolment is the biggest change to the pensions industry in living memory and companies have no choice but to be a part of it. Help and support are available, but the most powerful factor in making the transition successfully is the willingness of CEOs and finance directors to grasp the nettle and start making changes now.