Comprehensive details on the second consultation on workplace pension reform regulations

The DWP has published the second set of draft regulations for the 2012 automatic enrolment regime and its response to the consultation on the first draft. While some details will undoubtedly change following the consultation, this publication helps complete the picture of the future landscape for employers. In general, what is proposed is in line with expectations and changes from the previous consultation are positive but there are a few things that may cause some concern.

Changes to earlier proposals

Responses to the first round of consultation suggested that the proposed processes were too complex and some of the timescales too short for employers. The DWP has responded to this feedback and there are significant improvements now proposed. These are summarised in the table.

One point that caused some confusion in the first consultation was the position of schemes which take advantage of the facility to postpone auto-enrolment for up to 90 days - now three months - with an employer contribution rate of 6% of qualifying earnings, rather than the standard 3%. It was widely assumed that the employer could pay the higher contribution for only three months to make up those missed during postponement, with the rate then reverting to 3%. It has been confirmed that postponement is only possible if the rate is permanently 6%.

A new issue for employers opting for postponement is that they may have to implement different procedures for staff on contracts of up to three months, who it’s proposed must be auto-enrolled from day 1. This is most likely to affect employers with seasonal peaks such as hotels, and the likelihood is that they’ll choose personal accounts which don’t have the deferment option. However, it means that employers who do choose the postponement option will need to consider treatment of temporary staff. If these are largely hired through agencies, it may be worth ensuring that the agency is the formal employer.

New consultation

Most of the new consultation was put out with an abbreviated six week deadline for comments, meaning that if you’re reading this after 5 November it’s already finished. Fortunately most of it isn’t too controversial.

Timing of implementation
This has attracted the most attention following publication of the consultation, with comments about the Government effectively delaying personal accounts. It appears that the longer implementation period may be largely to ensure that there’s not a logjam at the Pensions Regulator (tPR) or the personal accounts scheme, but there may also be a desire not to place too heavy an additional burden on employers shortly after the recession.

There are two elements to the implementation period, which are known as ‘staging’ and ‘phasing’.

• Staging describes the process of imposing auto-enrolment requirement on employers. The plan is that employers will be brought into the new regime -over a three year period from October 2012, starting with the largest employers and moving down to the smallest. Most financial advisers are likely to see the bulk of their employers being required to comply sometime in 2013. The first tranche in October 2012 is likely to be mainly the mega-employers, while 2014 and 2015 are likely to be the long tail of very small employers. However, a few randomly-selected small employers will be brought in earlier to test the system.
  
  It will also be possible for employers to choose to start the process earlier than their set date, but they will have to be able to convince tPR that they already have a qualifying scheme in place or can establish arrangements by their chosen staging date. The last thing tPR wants is to have to start enforcement action against employers who have chosen to go early but been unable to deliver.
   
• Phasing describes the process of increasing the contribution rate to the ultimate level of 8% of qualifying earnings. Originally it had been expected that the clock would start ticking on this in October 2012, but it’s been confirmed that the intention is to delay any increase above the initial level until all employers are brought into the system. The table below shows the contribution levels, which will only reach their final level in October 2016.

Employers who run defined benefit schemes can defer automatic enrolment until the end of the three year staging period, but if they close the scheme before then they will have to back-date contributions to the new defined contribution arrangement to the date when they would otherwise have had to comply with employer duties.

Employees not auto-enrolled
There are two groups of workers who will have the right to join an employer-arranged pension scheme even though they are ineligible for auto-enrolment:

• Those aged 16 to 21 or over state pension age but under 75 are not automatically enrolled but can opt in to the employer’s qualifying scheme. If they do, the normal contribution rules apply, including those for the employer. The employer must inform such staff of their rights, and they can opt in through a written instruction to the employer.
   
• Those with earnings under £5,035 a year can choose to join a pension scheme through the company they work for, but have no right to employer contributions. Again, the employer must tell them about their rights, and arrange an appropriate pension scheme if they choose to contribute. It doesn’t have to be the same scheme as is used for automatic enrolment, although in most cases it’s likely to be the same one.

Automatic re-enrolment
If employees choose to opt out, the employer has to go through the auto-enrolment process for them every three years. There will be a single re-enrolment date for each employer, which will be every third year on the anniversary of the date when the employer duties commenced. Employees who have opted out within 12 months before that date don’t have to be auto-enrolled at this stage.

Changing scheme
It will still be open to employers to change the qualifying pension scheme they use for auto-enrolment, but there mustn’t be a long gap. The draft regulations allow for up to a month to finalise administration. In practice, when an employer decides to change scheme the move is generally immediate with no break in contributions.

Ensuring that contributions meet the minimum requirement
One of the big issues being debated over the past couple of years has been the difference between qualifying earnings under the new regime - all earnings between £5,035 and £55,400 in 2006/07 terms including bonuses, overtime etc. - and the more normal pensionable earnings definition of basic salary. In general, the latter will result in a higher monetary contribution if the same percentage of earnings is paid in, but even good pension arrangements may have some who lose out because they have high earnings on top of basic salary. There are two possible routes for employers to follow on this:

1. Employers can do a reconciliation at least yearly for all employees, and if the contributions actually paid are lower than the legal minimum the employer must make up the difference.
    
2. Employers can certify in advance that they believe they will meet the minimum requirement for all employees. At the end of the year they must do a sample check, with the minimum proportion of staff sampled depending on employer size. There are then three circumstances in which they must take further action:
   
    If the contribution for any individual has been more than 5% below the required amount, the employer must make good the shortfall for that individual.
   
    If more than 10% of those sampled have a shortfall, the employer will have to make good the shortfall for all scheme members who have lost out.
   
    If any individual has lost out in two consecutive 12 month periods, the employer will have to make good the shortfall.

The tolerances are lower than the industry had hoped for, and it’s possible that many employers will consider that the certification process is too onerous and opt instead for reconciliation.

Pay reference periods
Collection of contributions will be based round the individual’s pay reference period. This is defined as the frequency with which the individual is paid, or one week if longer. The idea is that employers won’t be able to delay deducting contributions for, say, a month if staff are paid weekly. On the first payday when the employee has qualifying earnings (i.e. those over the equivalent £5,035 a year in 2006/07 terms) the company must deduct contributions and add in the employer ones. The one exception is where there is a spike in pay – for example, a bonus – and earnings over a 12 month period are lower than the threshold. In that case employees do not have to be automatically enrolled or have contributions deducted.

The reference period for checking that contributions have met the minimum requirement is 12 months.

Defined benefit, hybrid and overseas schemes
There are draft regulations covering these schemes, which I won’t go into in detail here. In general, they look sensible.

Employer compliance
Employers will be required to inform tPR about how they have met their obligations within nine weeks of their staging date, and every three years after that. Employers, pension schemes and pension providers will have to retain records for six years, including details of opt-outs.

There will be a fixed £500 penalty for employers who fail to comply, followed by penalties of between £50 and £10,000 a day for persistent or serious non-compliance, depending on employer size. Various other sanctions for tPR are also being put in place.

Default funds
The consultation on default funds for GPPs and auto-enrolment under group SIPPs was issued separately from the main consultation document, and has a longer consultation timescale – until 17 December. The aim is to produce guidance for providers to follow, rather than prescriptive regulations.

In brief, the default option for a GPP should have total charges within the stakeholder cap, should be appropriately diversified and should have a suitable de-risking strategy, taking into account the retirement profile of the members. Auto-enrolment into a group SIPP will be allowed, but should be into a default fund similar to the one required for a GPP.

These proposals seem sensible, though we may have some concerns that a charge cap has crept into the new regime. However, where individual advice is not being offered it doesn’t seem unreasonable that charges should be within the stakeholder maximum.

Conclusion

Overall, the new regime seems to be proceeding along sensible lines. It still looks quite onerous for employers in places, but the simplifications now proposed are welcome. The extended ‘staging and phasing’ period reinforces the importance of ensuring that employers don’t hold back on pension provision as they wait for the new requirements, because if they do their staff could lose out on several years of worthwhile pension contributions. Advisers will want to make employers aware of the proposed changes, but the key message is that they need to act sooner rather than later.