With its cosy sounding clever name, “NEST” (the acronym for the new “National Employment Savings Trust”) is in danger of distracting attention away from the more important “automatic enrolment” scheme of which it is a part, albeit an important part. The “automatic enrolment” scheme is due to start on 1 October 2012 and is designed to ensure that many more workers than at present will have their own private pension to top up their State Retirement Pension.
Official estimates are that some 7 million people are not saving enough for retirement. Under current law all except the smallest employers are obliged to offer access to some form of pension scheme to employees but in general employees have to take active steps to join. For various reasons, inertia among them, many do not. Automatic enrolment will ensure that as a general rule employees will automatically become members of a pension scheme. Rather than having to opt in they will have to take active steps to opt out if they do not wish to continue as members.
Automatic enrolment was one of the key recommendations of the Pensions Commission (set up in 2002), which reported in October 2004 and November 2005. It is in operation in the USA where case studies have shown a rise in pension scheme membership following a switch from traditional opt in methods to automatic enrolment, from around 20-40 per cent to around 90 per cent membership amongst new employees three months after they were hired. The largest effect was among people with low incomes, minority ethnic groups and women.
That is all background to the Pensions Act 2008, enacted in November 2008. Under that Act most employees will have to be enrolled into an “automatic enrolment scheme” (technically, “The employer must make prescribed arrangements by which the jobholder becomes an active member of an automatic enrolment scheme with effect from the automatic enrolment date” - Pensions Act 2008 s.3(2)). The scheme can be the employer’s own scheme provided some quite complicated certification conditions are met or it can be the government approved NEST scheme. Arrangements for using the NEST scheme will be kept simple and it will be relatively inexpensive (the Government has said that it will cost micro firms with up to four employees £46 per person in administration but the Federation of Small Business believes this is a “gross underestimation”).
Under the current proposals, the new duty on employers will begin for larger employers on 1 October 2012. Application to all employers will be phased in over a four year period based on size. Once in force eligible “jobholders” be automatically enrolled into a qualifying automatic enrolment scheme. An eligible “jobholder” is someone who meets the following criteria:
- works under a contract of employment or has a contract to perform work or services personally and is not undertaking the work as part of their own business;
- ordinarily works in Great Britain;
- is aged between 22 and State Pension age; and
- has qualifying earnings payable by the employer in the relevant pay reference period.
Single person directors where the company has no other employees, members of the Armed Forces and members of the Combined Cadet Force, Sea Cadet Corps, Army Cadet Force and Air Training Corps do not count.
Minimum contributions will be calculated on earnings in a band of between £5,715 and £38,185 at today’s prices. Following automatic enrolment, a minimum of eight per cent of earnings within the earnings band would be contributed to the pension, with at least three per cent coming from the employer.
All businesses, even those with only one or two employees, will have to participate. The Federation of Small Business says “the average small firm – those with four employees earning an average salary of £25,000 – will pay at least an extra £2,550 per year in administration and pension costs”. The FSB calculation is based on an employer with four employees each earning the UK average annual salary of £25,428 per annum. 3% of the band (i.e. £25,428 – £5,715 = £19,713) is £591.39 per employee paid by the employer per year once the scheme is fully operational, from 2017. Adding to this the £46 per employee Government estimated administration cost for a firm with four employees gives a figure of £637.39 per employee. This equates to just under £2,550 for four employees.
The Federation of Small Business is calling for micro-businesses to be exempt. This seems unlikely as the October 2010 DWP review “Making automatic enrolment work” has recommended against exemption for micro-businesses for three reasons:
- To do so would exclude 1.2 million employees from automatic enrolment.
- There would be substantial practical problems in enforcing boundaries. Identifying those employers with five employees at any one time is almost certainly beyond the capacity of current systems. In addition, incentives to hide or distort the number of employees could be considerable.
- A significant disincentive to business growth would be created. The pension costs alone of moving from four employees to five could come to more than £1,500. In addition, some competitive distortions might be created between employers either side of the size cut off.
The October 2010 DWP review “Making automatic enrolment work” is a lengthy document but an excellent source of detailed information about the scheme. The rest of this note consists of a few short interesting verbatim extracts from it:
“current proposals … involve automatic enrolment on the first day of employment”; “we believe there is a strong case for giving employers the opportunity to have a waiting period of up to three months…This would allow employers to automatically enrol their employees at any point in the first three months of their employment (although workers who wish to opt in and receive an employer contribution in this period would be able to do so)”.
“…we propose a much simplified certification process [note: i.e. for employers using their own schemes rather than NEST]. Automatic enrolment requires minimum contributions based on a very particular definition of pay, total pay between a floor and a ceiling. Most existing pension schemes involve contributions defined as a percentage of all basic pay (not above some floor). Employers who run good schemes at present want certainty over whether contributions based on these definitions are enough to meet the legislated amounts. If they have to change their scheme rules to achieve this, we believe there is a real risk that the revised rules may be somewhat less generous overall. So we are very keen that a certification process is as simple as possible. A process we think would work would ensure that any scheme which met one of the following criteria could be certified as meeting the requirements: …”
“… charges [for NEST] are designed to make NEST self-financing in the longer term. Income from these charges will take some time to build up, however, so the scheme will be funded in the short to medium term by a loan from Government. It is estimated that NEST will be self-financing by around 2030″.
“… There is one important change that we do recommend. The currently proposed threshold is very low, well below the current income tax threshold. In addition, contributions are due from the first pound earned above that threshold. This means that many people on very low earnings will build up very small pots indeed, potentially damaging the credibility of the reforms. We propose that people should only be automatically enrolled once they reach the income tax threshold (which the Government has announced will be increased to £7,475 in 2011, equivalent to £7,336 in today’s prices), but that contributions should be on earnings in excess of the National Insurance earnings threshold (£5,715 in today’s prices). This will avoid automatically enrolling those not earning enough to pay income tax, will ensure that the very tiny levels of pension contribution possible under the current proposals are avoided, and will ensure that many who would benefit from automatic enrolment are not excluded by a higher threshold. Our intention is that workers who earn between these two thresholds would be able to opt in and receive an employer contribution if they choose to do so”.