UK: The Nesting Instinct

Last Updated: 5 July 2010
Article by Ian Luck

Nest (previously personal accounts) could spell trouble for employers by increasing employment costs with no scope for legal avoidance.

In the run up to the general election you would have been hard pressed to find any meaningful references to what the future of pension provision might look like in the UK. This was hardly surprising as, although it impacts on so many people, the changes are likely to be felt many years from now and who knows what political party (or parties) will be in charge at the time.

So the legislation introducing personal accounts, which has now been renamed as the National Employment Savings Trust (Nest), remains in place – ready to inflict the most far-reaching changes to the pension landscape in about fifty years.

Since the early 1960s, it has been a requirement for nearly all employees to be members of either their employer's pension scheme or the second tier of the state pension system, providing an earnings related pension in addition to the basic state pension.

Come 2012, employers and employees will still make earnings-related contributions towards the second tier of the state benefit system, but the pension payable will cease to be earnings-related. This will (eventually) become a flat-rate top up to the basic state pension. The link to an earnings-related pension will be broken for millions of people.

Instead, employers will be required to establish a qualifying workplace pension scheme (QWPS) for their eligible employees. They will then have to enrol their employees into the scheme and contribute on behalf of any employee who decides not to opt out of the scheme. If the employee remains in the scheme, the employer will eventually be required to pay a minimum of 3% of the employee's band earnings (currently between £5,035 and £33,540 per annum).

Employers unable to, or unwilling to, set up a QWPS of their own will have to make these contributions into the default government-run scheme – Nest.

These requirements are being phased in between October 2012 and September 2016. Every employer has been allocated one of forty-three dates during this period when they will have to comply with the regulations. Based on the estimated numbers, the million or so employers that exist in the UK will have 10 to 12 million employees within pension arrangements; perhaps up to half of which will be in Nest.

So what might drive employers to settle for Nest over a pension scheme that they have designed, chosen, and can oversee?

It is hard to see efficiency at the centre of that decision. After all, the record of recent governments controlling huge projects is not great. Couple that with employees, once they have been auto-enrolled into the pension, being able to opt out and receive a refund of the contributions that they are required to pay, only to be re-enrolled three years later, and you can see the nightmare that might ensue.

Perhaps cost will be the deciding factor. One of the main features of Nest when it was first introduced was that it would have a low annual management charge of 0.3%. Now, 0.3% is low even for the largest and most attractive of employer-sponsored schemes available on the market today and a lot less than the government-imposed stakeholder charging structure. So it is hard to see that being possible.

However, the charges that will be levied under Nest were recently confirmed as 0.3%. But, in order to cover the cost of establishing the scheme and paying back the government loans that will be required to ensure that someone wants to run it, there will also be a 2% charge on all contributions from outset for an unspecified period. Exactly for how long this will be required is unknown and will no doubt depend on how successful Nest is in attracting and retaining members.

So that is the equivalent of a 98% allocation rate, which itself may sound strangely like pensions have come full circle for anyone that remembers capital units. As such, it will not be as easy for employers as they might have been hoping to opt for Nest to ensure that their staff have the cheapest option.

A wider concern for employers and advisers alike has always been ensuring that the pension into which an employee is automatically enrolled remains suitable. This is particularly true for low earners where the current means-testing of the state benefits system is such that employees might lose the benefit of every penny that they have saved within their private pension arrangements. A particularly difficult thing to swallow if you had no choice in whether you joined the pension in the first place due to an automatic enrolment process.

However, there might be some good news on the situation. The new Pensions Minister, Steve Webb, said: "It will have to be addressed before 2012 if the launch of personal accounts is not to be undermined by doubts – ill-informed or not – about whether it will be worthwhile saving." It will not be easy to sort out the problems that means-testing poses, but it is good to see that it is at the forefront of the new Government's mind.

The Government's document, Programme for Government, contained even more good news: "We will simplify the rules and regulations relating to pensions to help reinvigorate occupational pensions, encouraging companies to offer highquality pensions to all employees, and we will work with business and industry to support auto-enrolment."

Nest is interesting by its omission, but it is clear to see that if you have been putting off making any changes to staff pension arrangements, hoping it would all go away, you are going to find that auto-enrolment appears before you like a very large cuckoo.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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