Preparing for the bombshell

Current population projections suggest that the number of people aged 65 and over will almost double by 2055. Further, with the Department for Work and Pensions estimating that around seven million people are not saving enough for retirement, urgent action is required.

"People are living too long," says Adam Potter, head of sales for corporate pensions at Aegon Scottish Equitable. "The government can't afford to fund our pension income anymore so it's looking to individuals and their employers to take on this responsibility."

To help shift this responsibility, there are already some legal requirements in place for employers under The Welfare Reform and Pensions Act (1999); these came into force in 2001 and state that, as a minimum, any company with five or more full-time employees must provide access to a stakeholder pension. This must be selected through an employee consultation process and you must be prepared to deduct employee contributions through payroll if they want you to do this.

Simple setup

Once a stakeholder scheme has been selected, it is straightforward to set it up for your employees. "Talk to a provider," says Martin Palmer, head of corporate pensions marketing at Friends Provident. "It will provide you with all the paperwork you need and, because it doesn't want to incur costs if no employees join the scheme, it will set it up as soon as one of your employees signs up."

However, while there are rules around what you offer and how you communicate it, there is no requirement to make a contribution. Furthermore, employees can choose whether or not they join.

The stakeholder pension represents the minimum terms and you can choose to offer a more sophisticated scheme. "Stakeholder is a lower-level plan. For more investment choice and flexibility you could offer a group personal pension or, for the greatest level of flexibility, a group self-invested personal pension," explains Colin Batchelor, head adviser of pensions technical service at Legal & General. Both of these types offer employees access to a wider range of investments, with a GSIPP providing the most choice. "Employees would have access to 300 to 400 investment choices, plus any other qualifying investments such as other funds and shares. Executives could even use a GSIPP to invest in their business premises," adds Batchelor.

Multiple options

Deciding on the type of scheme that you want to offer your employees is only the first stage in implementing a pension. Chris McWilliam, senior consultant at Aon Consulting, highlights that you need to consider various aspects of how it will work to extract the most from it: "How much do you want to pay into it for your employees and with what sort of contribution structure? You could pay a fixed amount or offer to match their contributions up to a set percentage. You should also think about how you communicate your scheme because this can make a huge difference to take-up."

You might also want to consider offering your employees salary sacrifice as a means of contribution. Around 50% of medium to large companies offer this and it has advantages for you as well as for the employee. "It's a great idea, very cost-effective and definitely worth considering," remarks Batchelor, adding that the only employees that should not use salary sacrifice are the low paid, as it can affect their eligibility regarding benefits.

With salary sacrifice, rather than paying a pension contribution out of gross pay, the employee agrees to take a reduction in their salary and to have this redirected to the pension scheme, generating a tax and national insurance saving. On top of this, there is also a National Insurance saving because of the reduction in salary.

The downside is that having a lower salary can potentially have knock-on effects in other areas of the employee's financial affairs. For example, life assurance is generally based on a salary multiple, so cover could be reduced. Likewise, where overtime is paid this would be based on the employee's salary and a reduced salary may affect an employee's ability to borrow from a mortgage company. Potter says that this needn't be a problem, though: "You can bypass this by having a reference salary - which would be the salary before any sacrifice - using this for other benefit calculations or to give to mortgage companies."

Whether or not you decide to play an active part in helping your employees plan for retirement, come 2012 you will have to be more involved in your employees' pensions. "Stakeholder hasn't worked," says Potter. "There's no compulsion to do anything, so many employees aren't paying into a pension for a future income."

Mandatory contribution

In October 2012, there will be greater compulsion for employers to contribute to employee pensions; the new rules apply to all employers regardless of size. As well as having to provide access to a pension scheme, employees will be enrolled into it automatically; they will be able to opt out but will be re-enrolled automatically every three years.

To ensure that employers do not coerce employees to opt out, there will be punishments in place for employers found breaking the rules - these are likely to be as much as £50,000, with prison sentences of up to two years for those who knowingly break them.

There are conditions regarding who can join the scheme, with employees aged between 22 and the state pension age (currently 65 for men and 60 for women) earning more than the minimum level (£5,435 a year in 2008-09) being eligible. Employees outside this age band will be able to join, though this will be on a voluntary basis.

More importantly, for those that do not opt out, a minimum 8% pension contribution will be in place, which will comprise 4% from the employee, 3% from the employer and a further 1% from tax relief. For someone taking home average pay of £23,700, this represents an annual pension contribution of £1,900.

Comprehensive inclusion

Contributions will also be based on a slightly different income calculation: rather than basing them on basic salaries, contributions will be payable on the total earned, meaning that bonuses will be included. However, to soften the blow, it will be compulsory to make contributions only on a salary band. This is effective for annual salaries of £5,435 to £36,000 a year, based on figures from 2008-09.

Because of the scale of this venture, the government plans to phase it in from October 2012. Rather than jumping straight to these contribution levels, a sliding scale will be in place for the first couple of years, starting at 1% in 2012 for the employer and employee before rising to 2% for the employer and 3% for employee - including the tax relief - in 2013.

As well as the sliding scale, larger employers are expected to be the first to comply with the new rules with smaller firms following soon after.

Although employers will be able to use existing pension schemes, a new form of pension - the Personal Account - will be introduced. This will be run by the Personal Accounts Delivery Authority - a non-departmental public body - and will be regarded as the minimum pension.

Because it is designed specifically for low-to-moderate earners that might not have had access to an occupational pension before, it will be fairly simple. Charges will be low, with current proposals suggesting that the annual management charge could be as little as 0.3% long term. This level of charging means that investment options will also be limited, with investors likely to have a choice of a default fund with lifestyling incorporated or some general funds. Additionally, it will have a maximum annual contribution level of £3,600 - based on 2005 figures.

These rules have been laid out by the incumbent government and, with a general election expected in the next year and a new government likely to come to power, few expect there to be no tweaks made to the proposals. Potter comments: "All the main political parties agree that something has to be done to increase pension provision. While I can see another party making minor amendments to put their stamp on the regime, they all agree that we can't fall back on the state in our retirement."

Preparing for 2012

Whatever your current pension arrangements, now is the time to start thinking seriously about the new regime. "You don't need to do anything now other than consider how the new pensions regime will affect your business," remarks Palmer.

For starters, even if you have a pension in place already, auto-enrolment means that the new regime is likely to generate increased costs for employers with their having to make contributions of 3% of employees' qualifying income.

Additionally, even where a contribution is being made already, this could mean further increases in costs because the new rules apply to bonuses as well as basic pay. As an example, Mercers is putting an annual figure of £3bn on the additional costs to employers of the new pension regime.

"For an employer with no pension provision in place at the moment, this could mean an increase of 2% to 2.5% of pay roll, depending on the makeup of the employees," says Andy Tully, pensions policy manager at Standard Life.

Expense

Where a scheme is already in place, auto-enrolment has the potential to increase costs further still; it is expected that companies could see employee take-up increase to between 85% and 90%. "An employer with a more generous scheme than the Personal Account could find their costs escalating in 2012 when more employees join," warns Tully. "They could look at reducing the level of contribution to keep the cost of the scheme the same but this is very obvious to employees and sends out negative signals. Instead, they might want to restrict entry to the scheme by setting up a separate one for future entrants."

This could have negative implications, as Batchelor explains: "If employers are concerned about the future costs of a pension scheme then they might look to downgrade the benefits to the level proposed by the government. This wouldn't be so good for those employees affected." Preparing for increased costs is imperative as 2012 approaches - employers are looking at pay freezes or other benefit cuts as a means to release the funding for future pensions.

Tully adds that other countries' experiences in introducing pension compulsion illustrate what could happen in the UK. Australia has a well-established pension regime, having introduced compulsory pensions in 1986; these initially required an employer contribution of 3% but this has increased to 9% today. Tully explains the knock-on effects: "Pension costs have increased in Australia but there has been a reduction in pay rises," he says. "I expect this will happen in the UK too.

As well as preparing for the costs, another consideration you might want to make now is whether or not you want to go for a Personal Account or introduce a different scheme. "Do you go for the minimum or something more sophisticated? You might want to check out what your competitors offer too, especially if you want to be seen as an employer of choice," Potter explains.

As pensions become a standard part of the employment package, being able to offer something extra will help you win the battle for the best employees.