The Road to 2012: Will your scheme qualify?

Introduction

Just a few months after the lighting of the Olympic flame in 2012 the marathon implementation of the employer duty of auto-enrolment will also ignite. Just as the athletes are already training in preparation for the big event, employers should be starting to plan how they will comply with their new duties.

Key points

Under the automatic enrolment requirements, employers will be required to enrol their “eligible jobholders” into a qualifying pension scheme.
The eligible jobholder will then have the option to opt-out of the pension scheme if they wish to do so.
Eligible jobholders are workers between the ages of 22 and SPA with overall earnings of at least £5,0351 per year.
The new auto-enrolment duty will come into force in stages starting with bigger employers from October 2012.
An employer may choose to enrol their eligible jobholders into their own designated “qualifying scheme” or use the Government established savings scheme, NEST.2

What is the start time?

The new auto-enrolment duty will come into force in stages between October 2012 and October 2016, applying to bigger employers first and then smaller employers. The Pensions Regulator has said it will write to employers 6 to 12 months before their “staging date”, to notify them when the new duty will apply to them.

What is a Qualifying Scheme?

A qualifying scheme could be either an occupational pension scheme or a personal pension scheme and normally must be registered under the Finance Act 2004.

Importantly, a qualifying scheme must also satisfy the quality requirements. The quality requirements vary depending on whether the scheme is a DB or a DC arrangement.

DB – what are the hurdles?

A DB arrangement will meet the quality test if it is contracted-out on the reference scheme test basis3 or if it is broadly equivalent to, or better than, the “test scheme standard”.

Broadly, the test scheme standard is based on a pension payable from age 65 equal to 1/120th of average “qualifying earnings”4 in the last three tax years before the end of pensionable service for each year of pensionable service (subject to a maximum of 40 years). The pension is also revalued in deferment and increased in payment in line with the increase in the retail prices index (subject to a maximum of 2.5% per annum).

If an employee is entitled to become an active member of a qualifying DB arrangement automatic enrolment into the DB scheme may be postponed until October 2016 (but back payments may be required if the DB scheme is withdrawn after the employer’s staging date).

DC – the triple jump

The quality test for a DC arrangement is based on the contributions made to that arrangement. The contributions from the employer must be at least a minimum amount and the total combined contributions from the employer, member and tax relief must also be at least a minimum amount.

The contribution test is being phased-in in three stages:

Between October 2012 and October 2016 the minimum employer contributions will be 1% of “qualifying earnings” (with minimum overall contributions of 2% of qualifying earnings).
Between October 2016 and October 2017 the minimum employer contributions will be 2% (with 5% overall minimum).
After the transitional period ends, from October 2017 onwards the minimum employer contributions will be 3% (with the 8% overall minimum intended also to comprise 4% member contributions and 1% tax relief).

An eligible jobholder’s “qualifying earnings” are his or her gross annual “earnings” between £5,035 and £33,540. The definition of earnings is broad and includes salary, wages, commission, bonuses, overtime, statutory sick pay and statutory family leave pay.

If an employer enters the game after the 2012 start date (because its staging date is later) the phased contributions applicable at their staging date will apply to it. For example, if the duty first applies in January 2017, the employer will be required to pay 2% (with a minimum overall contribution of 5%).

In the run up …

Employers should start to identify which of their workers are eligible jobholders and consider what pension to provide for them to comply with their new duties.

The DWP is continuing to work on the details for the adaption of the quality tests for hybrid, career average and cash balance schemes in the UK and also for non-UK pension schemes.

However, employers should be wary of taking action too soon as the outcome of the General Election may yet change the rules of the game.

1 This figure is based on 2006/07 earnings and will be uprated
2 Previously referred to as the personal accounts scheme
3 Broadly, for a scheme to satisfy the reference scheme test basis at least 90% of members must have benefits equal to or better than a “reference scheme”. The reference scheme is a notional scheme which provides a pension of 1/80th of qualifying earnings for each year of service and also provides a 50% dependant’s pension on death of the member
4 See the definition in section on DC schemes below