UK businesses were rocked by the news of the government’s auto-enrolment scheme for pensions several years ago. Small and medium-sized enterprises (SMEs) immediately began to fret about how they were going to meet the implications of the law without harming either their workers or their own bottom lines. Fast forward to the pension changes resulting from the budget of 2014. Between pension transfers, trivial commutations, new drawdown rules, and more, the pension environment has become more complex.
At the heart of the most recent changes is a desire by the government to protect pension pot owners from various schemes and practices that could leave them with considerably less at retirement age than planned. The changes give workers several new options, but also make it more difficult for businesses to manage pension schemes effectively. The only good news here is that, if the government succeeds in its plans, more Brits will be financially secure at retirement age.
Multiple pension pots
As you already know, it is rare for a worker to remain in the same job for his or her entire working career. Workers routinely switch employers as they look for a better income and more opportunities. The result of all this switching is a larger number of smaller, stranded pension pots left behind when workers move on. However, starting next year, workers will have more options for those smaller pots.
Some workers will leave those pots alone until retirement age, at which time trivial commutation will allow them to take up to £30,000 in a tax-free lump sum. Workers can take up to three smaller pension pots without tax penalty. Anything above a combined three pots at £30,000 will be taxed at the individual’s marginal rate. This is good for workers, but it leaves businesses with many small pots to continue dealing with.
A pension transfer is another option for some workers. Pension transfer experts suggest this is only a good deal if the pension scheme offered by the individual’s current employer is favourable to a transfer. Some schemes do not allow transferring funds in from other pots; others charge fees high enough to make transferring impractical. It is up to the individual worker to get sound advice regarding pension transfers before making a switch. As for SMEs, they have to decide whether they want their current pension schemes to accept transfers, and at what cost.
Setting up new pension schemes
Businesses can meet the obligations of the law by running their own pension scheme or setting up a scheme with a qualified provider. Those who choose to run their own schemes are required by law to keep its assets separate from business assets. Mixing the two is not only illegal, it is also an invitation for financial mismanagement in the future.
Assuming most SMEs will likely work with a pension scheme provider, there are some obligations that need to be given the proper attention:
- Scheme set up – Businesses and pension providers need to work closely together to determine the details of how the pension scheme will be set up. All of the details need to be worked out prior to the start of auto enrolment so that workers can be added to the scheme at the earliest possible date.
- Employer contributions – The law requires employers to make minimum contributions to workplace pension schemes. Company officers must determine whether to keep contributions at the minimum or to increase them.
- Worker contributions – Workers will also be contributing to their pension schemes for withholding. The business and its pension administrator need to work out contribution due dates to ensure money is withheld and contributed on schedule.
- Opt-out plans – Under certain conditions, workers can opt out of a workplace pension plan by simply submitting an opt out notice. However, companies must determine how the pension provider handles the dissemination of opt-out notices and the options workers have for submitting them.
- Data collection – Pension providers need certain kinds of information in order to enrol a worker in a pension scheme. How this information is collected, managed, and protected is of great concern. Policies must be put in place to protect every worker while also making sure auto enrolment is completed.
Auto-enrolment is not the way many of the UK’s SMEs would like to see pension schemes offered to workers. Nonetheless, auto-enrolment is now the law. Businesses can be fined and otherwise penalised if they do not adhere to the new pension regulations.
Pension drawdowns
The one area of major change that does not directly affect businesses is the changes in drawdown flexibility. Prior to the 2014 budget, pension pot owners were severely restricted in how they could use pension monies, forcing the average worker into purchasing an annuity at retirement age. From next year, that is no longer the case.
Pensioners will be able to take up to 25 per cent of a pension pot as a tax-free lump sum. The remainder can be gradually drawn down or also taken as a lump sum, taxed at the individual’s marginal rate. Those who wish to transfer pension funds into other investment schemes have a longer list of eligible options as well.
The average worker will still likely choose an annuity because of its guaranteed income for life. However, if annuities continue to perform poorly as compared to other investments, we may see more pensioners opt for something different. Rental property is an option many are looking at right now.
Residential property is looked at more favourably because it outperforms most annuities. In fact, property is among the fastest-growing investments among pension potholders in the UK. They are drawing down their pensions and investing the majority of the cash in buy-to-let property they assume will provide them with a better retirement income.
Delaying action until 2015
The government realised the new pension rules being implemented next year would not be available for those who are already making pension decisions right now. Therefore, they extended the amount of time a pension can be left alone before a decision has to be made, allowing workers to delay further action until next year. This means that your business may have retired individuals still involved in pension plans. You will have to wait it out until next year, along with those former workers.
The changes to the UK pension rules are the biggest we have seen in 50 years. They have certainly changed the pension landscape for both SMEs and workers alike. Now more than ever, it is important for stakeholders to understand how each of the rule changes affects them. A failure to understand the impact of the changes makes it that much more difficult to optimise pension funding.
From the pension transfer to the trivial commutation, the new pro-worker changes mean pension schemes will never be the same. Financial planning is in order if the average worker is to make the most of his or her pension funds. Nevertheless, the same also holds true for businesses. Now is the time to make sure your pension scheme is compliant with the law and productive for workers.
