On your marks: Will your scheme qualify for auto-enrolment?

Introduction

With the countdown to the Olympics well underway, the clock is also ticking towards the start of automatic enrolment. So while potential members of Team GB are put through their paces to qualify for London 2012, we examine the key elements of qualifying schemes which employers will need to consider in the run-up to the new duty.

Key points

Automatic enrolment will involve employers enrolling their “eligible jobholders” into a qualifying pension scheme.
Employers will be able to enrol their eligible jobholders into their own designated qualifying scheme or use NEST (the scheme set up by the Government to facilitate auto-enrolment).
The DWP has confirmed1 that employers will be able to use a waiting period of up to three months before the automatic enrolment duty applies.
Simplified certification requirements for DC schemes used as qualifying schemes will also be introduced.

The auto-enrolment duty

Starting in October 2012, employers will be required to enrol their eligible jobholders into a qualifying pension scheme. (An eligible jobholder is a worker between the ages of 22 and SPA, who earns more than £7,4752.) The duty will apply to the largest employers first, with those employing 120,000 or more persons in their PAYE scheme needing to be on the starting blocks in October 2012.

Many employers already have pension schemes in place which could be used for auto-enrolment purposes. When considering whether to use an existing scheme, employers will need to check that it meets the relevant quality requirement to be a “qualifying scheme”.

What is a qualifying scheme?

A qualifying scheme could either be an occupational pension scheme or a personal pension scheme and must normally be registered under the Finance Act 2004. It must also satisfy certain “quality requirements”, which vary depending on whether the scheme is a DB or DC arrangement.

Hybrid schemes, which have elements of both DB and DC, will need to meet either the DB or DC test, or a combination of the two.

DB qualification

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

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 CPI (subject to a maximum of 2.5% per annum).

CARE schemes

As a general rule, schemes providing career average salary benefits will be excluded from being qualifying schemes. Qualification can, however, be achieved for CARE schemes if additional hurdles are jumped.

A CARE scheme will qualify if it is broadly equivalent to, or better than, the test scheme or if it is contracted-out, and where accrued benefits are guaranteed to revalue at a rate of no less than CPI capped at 2.5%.

If revaluation is only applied on the exercise of a discretionary power contained in the scheme rules, the scheme will be able to qualify if the scheme’s funding takes account of the discretion. The rate of revaluation must also be at least CPI capped at 2.5% and must be expressly provided for in the scheme’s statement of funding principles.

The DC test

The quality test for a DC arrangement is based on the contributions to that arrangement. By the end of the transitional period,5 contributions payable in respect of the jobholder must be at least 8% of qualifying earnings overall, with a minimum 3% contribution from the employer.

Recognising that many DC schemes treat only basic pay as “pensionable earnings” and require contributions to be deducted from the first pound, a new three tier “alternative quality requirement” is being introduced.

DC: The alternative quality requirement

DC arrangements will be able to self-certify that they meet the alternative quality requirement if they provide contributions in accordance with one or more of the following options:

a minimum contribution of 9% of pensionable earnings for each jobholder (including at least a 4% employer contribution);
a minimum contribution of 8% of pensionable earnings (with at least 3% from the employer), provided that total pensionable earnings of all relevant jobholders in aggregate constitute at least 85% of their total earnings; or
a minimum contribution of 7% of earnings is paid (with at least a 3% employer contribution), provided 100% of earnings are pensionable.

“Pensionable earnings” here must be at least equivalent to the jobholder’s basic pay.

Adapting your scheme for auto-enrolment

An employer contemplating using an existing scheme to meet its auto-enrolment obligations, will first need to consider whether it meets the quality requirements. If not, the scheme will need to be adapted.

Trustees (with the employer’s consent) may make certain changes by resolution to ensure compliance with the new regime. But as the types of changes which can be made in this way are limited, employers should plan ahead and take appropriate legal advice if more extensive changes are contemplated, and to ensure that any additional legislative hurdles6 can be overcome.

Employers who currently enrol staff automatically in an existing pension arrangement will also need to consider adapting their scheme to meet the auto-enrolment requirements. Even where the scheme in question already meets the quality requirement, there are specific timing and notice requirements which must be complied with.

1 Government response to consultation: Workplace Pension Reform: completing the legislative framework for automatic enrolment (January 2012)
2 In 2011/12 earnings terms. This figure is due to be uprated
3 Broadly, at least 90% of members must have benefits equal to or better than a ‘reference scheme’ (a notional scheme which provides a pension of 1/80th of qualifying earnings for each year of service and a 50% dependant’s pension on death)
4 Earnings between £5,035 and £33,540 based on 2006/07 figures (to be uprated), including: salary, wages, commission, bonuses and overtime
5 1 October 2018 onwards, subject to consultation
6 Such as consultation or the requirements of section 67 of the Pensions Act 1995