Mandatory pensions will push up costs for employers

some 14 million people in Britain aren’t saving enough for their retirement, according to estimates from the Workplace Retirement Income Commission (WRIC).

From next year, the first ten million people will be signed up to auto- enrolment pensions, which are being billed as the biggest change to UK pension provision in a generation.

The new legislation will mean that all employers will be required by law to contribute to workers’ pensions. In the first instance, employers will have to make a minimum contribution of 1 per cent, rising to 3 per cent by 2017 – so the cost implications are clear.

The shift to the new way of working begins on 1 October, 2012, initially for larger companies with 120,000 workers or more, but most medium-sized companies will be affected in early 2013. All businesses will be required to be fully compliant within four years.

So while you might think that your business might not need to take immediate action, it will be much safer to conduct a serious review of what you need to do now, rather than leaving everything to the last minute.

The vast majority of workers will be eligible for auto-enrolment, save for those earning under £7,474 a year, those who do not meet the age criteria and for those staff who actively opt-out. Businesses with a significant numbers of employees not currently in their pension scheme will face a substantial increase in direct pension costs, but also a significant knock-on effect on the running cost of pension schemes. Employers will need to: monitor the eligibility of all workers both at outset and on an ongoing basis; enrol eligible employees automatically into a qualifying pension scheme; and, for those employees that opt out, employers will need to re-enrol them on a three-year cycle.

Systems covering human resources, payroll and pensions will need to be fully integrated if the administration burden for employers is to be kept to a minimum.

KPMG has found these new requirements are leading employers to fundamentally review how they run their pensions schemes and to seek out new and different ways of delivering pensions that generate cost savings to offset the direct pension cost increase.

Most employers will use defined contribution (DC) schemes to meet their new obligations, but not all DC schemes are the same. For example, many medium and large employers operate trust-based schemes that run on an “unbundled” basis, which is to say that the administration and investment functions have been managed by separate, third-party providers.

This model has increasingly given way to “bundled” arrangements, where administration and investments have been managed by a single third-party provider, which helps to reduce costs and improve efficiency. KPMG’s experience is that in many cases employers can reduce operational costs by 60 per cent or more by exploring these alternatives.

It may be that companies will have a variety of pension schemes available to staff with new schemes running alongside existing pension provision. Smaller companies are most likely to use the National Employment Savings Trust (Nest) as an easy and affordable way to deliver benefits to staff, while larger firms may prefer their own schemes, or use multiple schemes for different groups of their workforce.

Regardless of which option is chosen businesses will need to do their homework. Employers will need to check their existing pension arrangements satisfy the qualifying criteria covering active members and, if they don’t, then changes will need to be made to schemes rules or other processes.

What is absolutely clear is that technology and systems interfacing together will be critical – October 2012 may feel like a long time away but, when you consider most employers may need to redesign schemes to maximise savings, review any existing schemes and importantly review and upgrade systems and allow time for testing before the “go live” date for auto enrolment, planning now is critical.

Whatever option businesses take, it is important that auto-enrolment succeeds so all involved have confidence that the legislation achieves its primary objective of delivering strong pension provision for the millions of people who currently do not save for their retirement years.

l Donald Fleming is head of pensions at accountancy firm KPMG in Scotland