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The financial and organisational implications of the Pensions Bill are potentially huge for businesses, says John Davies, head of business law at ACCA

21 Jan 2008

As the Pensions Bill received its second reading in the House of Commons in January 2008, ACCA explains the implications of the Bill for employers - especially small and medium-sized enterprises (SMEs) - who could face fines and imprisonment if they fail to comply with their obligations under the new system of personal pension accounts.

John Davies, head of business law at ACCA, says: 'The UK Government's aim is to ensure that more of us save for our retirement and to make it as easy as possible for those who currently do not save to do so. This is a praiseworthy objective. But much of the responsibility for putting the new scheme into practice is to be delegated to employers - especially SMEs. The financial and organisational implications of the Bill for businesses are potentially huge.'

Some of the ways in which employers will be directly affected by the Bill are set out below.

1 Costs of the scheme

The new scheme will call for heavy administrative involvement on the part of employers - if they do not currently afford access for their staff to any other type of scheme, they will have to enrol their staff in the new scheme, deduct and pay employer and employee contributions, and keep relevant records.

The Department for Work and Pensions (DWP) has estimated the costs to employers at around £230m in set-up costs, with ongoing annual costs of around £90m. But research conducted by Manchester Business School (MBS), using compliance cost data for the PAYE system, has estimated that ongoing costs alone could result in an annual additional compliance cost of £1.3bn for the UK's SME sector.

John Davies adds: 'Even that estimate does not take into account internal staff time and professional fees that businesses will incur in learning about the personal accounts scheme and deciding whether or not to opt-out of any current arrangements they may have.'

MBS estimates that a continued burden at this level would reduce the profitability of SMEs, leading to an overall reduction in corporation tax revenues of £397m. ACCA appreciates that the MBS figures and DWP's are estimates.

But an increase of anything like this amount in SMEs' administrative burdens - 15 times the DWP's own estimate - at a time when the Government is officially committed to cutting red tape and business compliance costs, would be an unacceptable price to expect SMEs to pay.

2 Auto-enrolment

The Bill aims to counteract the problem of employee apathy towards pension saving by requiring employers to enrol their staff automatically into the new scheme. If this is done, runs the argument, take-up will be maximised and individuals will be saved the trouble of considering a range of pension options.

This solution has the virtue of simplicity and certainty. But it is based on two assumptions - first, that joining the scheme will be in the best financial interests of those involved and, second, that the rate of subsequent opt-out by those involved will be low.

On the first of these two points, there remains considerable doubt as to whether the structure of the scheme will be such as to make it a worthwhile financial proposition for many in the target market.

On the second point, the DWP's research has suggested that the rate of subsequent opt-out will be low, and that most of those who have been automatically enrolled into the new scheme will be happy to stay in. But at this stage, the true level of opt-out cannot be forecast with any certainty. If it turns out that the rate of opt-out is higher than the DWP has so far estimated, then employers will be faced with having to administer regular opt-outs, after already having had to go to the trouble of effecting automatic enrolment and putting in place the procedures associated with deducting and paying over contributions.

Given this uncertainty, and the need to avoid imposing excessive burdens on employers, it would be sensible to delay the process of mandatory automatic enrolment until a new employee had worked for the employer for a specified period of time, say three to six months, which would correspond with normal probationary periods. This would help to ensure that individuals were not enrolled until such time as they had been able to absorb some basic information about the scheme and to make decisions on the strength of that information. This could in turn help to reduce the rate of subsequent opt-out.

John Davies says on this point: 'It is common for employees to be required to work a probationary period before being given a full-time contract. It is also common, in occupational schemes, for individuals to be required to work for an employer for a period of time before becoming eligible to join the scheme. To require employers to enrol staff into the new statutory scheme from day one, before they have had the chance to consider whether joining the scheme would even be in their financial interests, could be counter-productive for employers and staff alike.'

3 Earnings - what's considered, what isn't?

The Bill proposes that, for the purposes of the new scheme, pensionable earnings will include, as well as wages or salary, commissions, bonuses, and overtime. Those additional elements are often excluded from pensionable earnings by the rules of individual occupational schemes. The effect of including these additional elements will be that contributions, from employer and employee alike, will be higher. And at the same time it will involve extra work for the employer in calculating the contributions due.

4 Sanctions for failure to comply

Fixed penalty fines of up to £50,000, escalating penalty notices with a prescribed daily rate of up to £10,000 and/or potential imprisonment of up to two years are materially high sanctions for what will be, in the main, small businesses. The Bill appears generally to contain 'more stick than carrot' for the businesses that are going to be affected.

The serious implications of failure to comply make it crucial that information for employers and employees about the new scheme is highly publicised, understandable, and widely available in a range of formats.

John Davies concludes: 'Whether or not the proposed new pension scheme turns out to be a good financial investment for its target market, the way the scheme is to be organised will undoubtedly have the effect of adding to the statutory burdens on smaller employers, and this at a time when the Government is officially committed to cutting administrative burdens for the UK business sector. While it can validly claim that resolving the UK's pension crisis is a top national priority, it should develop the scheme in such a way that it avoids unnecessary bureaucracy and retains the goodwill of employers.'