NEST comes home to roost!

Introduction

Plans for the introduction of automatic enrolment and the new national pension scheme (NEST) got the green light yesterday, following the publication of findings from an independent review “Making automatic enrolment work” (the Review). As planned by the former Labour government,1 employers will have to start automatically enrolling “jobholders”2 into their own qualifying pension arrangement or NEST from October 2012.

Key points

While the broad structure for automatic enrolment and NEST looks set to remain as originally planned, the Review recommends a number of improvements, many of which are designed to simplify the auto-enrolment process.
The Review proposes increasing the threshold for automatic enrolment to £7,475 in 2011/12, with contributions payable only on earnings in excess of the National Insurance primary threshold.
The certification process for qualifying DC schemes will be simplified and employers will be able to take advantage of an optional three-month waiting period.
Although no exclusion is on the cards for small employers, the Review is “only content to recommend they remain within scope if other deregulatory options are implemented to ease their administrative burden”.

Earnings threshold

Originally, contributions under the automatic enrolment regime were to be paid on band earnings between £5,035 and £33,540 (in 2006/07 earnings terms). However, given the risk of individuals being automatically enrolled who may not benefit from pensions saving, the Review proposes aligning the threshold for auto-enrolment with the threshold for paying tax (£7,475 in 2011/12), with contributions payable only on earnings in excess of the National Insurance primary threshold (£5,715 in 2010/11). (Jobholders with earnings between these two thresholds should be able to opt in to saving and receive an employer contribution.)

This measure should help to avoid the build-up of very small pots by those with very low earnings.

Smaller employers

Many in the industry had called for an exemption for smaller or “micro” employers (for example, those who employ just one person, such as a carer or cleaner), given the disproportionate burden auto-enrolment could impose on those who, until now, have probably had little or no involvement with pensions. But as smaller employers tend to engage many of the individuals at whom the reforms are aimed, these pleas have been rejected by the Review. A cut-off point by size was also seen as a possible disincentive to business growth.

Simplifying the certification process

Employers wishing to use their existing scheme for automatic enrolment purposes will need to certify that the scheme meets the “quality requirement”.

DB schemes which contract-out using the reference scheme test will automatically meet this requirement, as will contracted-in DB schemes which satisfy a “test scheme standard” based on an accrual rate of 1/120th over a maximum of 40 years.

However, Labour’s proposals for certifying when DC schemes met the quality requirement were deemed to be unnecessarily complex as they hinged on the statutory definition of “qualifying earnings”.3 The Review endorses DWP proposals for a simplified three-step approach,4 with DC schemes able to self-certify if:

a minimum contribution of 9% of basic pay is paid to the scheme for each jobholder (including a 4% employer contribution);
a minimum contribution of 8% of basic pay is paid (with a 3% employer contribution), provided pensionable pay constitutes at least 85% of the member’s total pay; or
a minimum contribution of 7% of basic pay is paid (with a 3% employer contribution), provided 100% of pay is pensionable.

It is hoped that simplifying this process will reduce the incentive for employers to “level down” existing DC pension provision.

Waiting periods and staging

Also aimed at reducing the administrative burden on employers, the Review proposes the introduction of an optional waiting period of up to three months before an individual needs to be automatically enrolled. However, jobholders will be able to opt in during this period.

As the new duty will apply to larger employers first,5 the Review also suggests giving the largest employers (those due to enrol their jobholders in October and November 2012) the option of auto-enrolling from as early as July 2012.

Transfers

The original proposals for NEST banned transfers in and out of that arrangement. Acknowledging the realities of an increasingly mobile workforce and the advantages of being able to consolidate small pension pots, the Review not only recommends the removal of the NEST restrictions on transfers, but also a wholesale review “as a matter of some urgency” of how transfers in general can be made easier.

What next?

The recommendations represent good news for the millions of fledgling pensioners who (hopefully) stand to benefit from pensions saving for the first time.

Further details are expected to emerge in due course, as the Government takes on board the Review’s recommendations. But employers should now start planning in earnest how they intend to deal with auto-enrolment.

1 Please see our News “The Road to 2012: Building the foundations for new pensions saving” dated October 2009
2 Eligible workers in Great Britain between the ages of 22 and State Pension Age
3 Please see our News: “The Road to 2012: Will your scheme qualify?” dated April 2010
4 We understand that the DWP will be consulting on this model later in the year
5 The auto-enrolment duty will apply in stages, based on PAYE scheme size, starting with those who have 120,000 or more employees. Contributions to DC schemes will also be phased-in, with the full requirement due to apply from October 2017