Government gives green light to Nest and pension auto-enrolment

A question mark was raised over Labour's pension reforms when the new Government announced a review of pension auto-enrolment and Nest in its first Budget. The independent review team has come out in favour of the reforms, but has recommended some simplification of the new regime.

On this page:
Summary of changes to auto-enrolment proposed by the review team
Changing the thresholds
No employer exclusions
Reducing the employers' burden
Retaining Nest
Wider pensions changes.

The Pensions Act 2008 lays down the foundations of the previous Government's final pension reforms, in particular the introduction of automatic enrolment of "jobholders" into either a workplace pension arrangement or a national savings scheme, subsequently named the National Employment Savings Trust (Nest). When the coalition Government came to power, Chancellor of the Exchequer George Osborne announced in his first Budget statement the intention of reviewing the scope of auto-enrolment and whether Nest is necessary for it to work.

The independent review team, made up of Paul Johnson of Frontier Economics and the Institute for Fiscal Studies, David Yeandle of the EEF and Adrian Boulding of Legal & General, has now published the results of its investigations, a report running to more than 200 pages (on the Department for Work and Pensions website). It recommends that auto-enrolment and Nest go ahead, but proposes a number of changes, including a higher earnings threshold for auto-enrolment, the introduction of an optional waiting period before auto-enrolment is effected, and a simpler self-certification process for demonstrating compliance.

The review panel's starting point was that auto-enrolment should proceed but that certain aspects of it should be reconsidered, namely whether or not:

• there is a case for excluding a substantial tranche of workers from the regime, such as those earning below a certain level of income or those above a certain age;
• there is a case for excluding any particular group of employers, such as those with fewer than five employees, from the auto-enrolment regime;
• any changes to the implementation and details of auto-enrolment would enhance the policy; and
• Nest is necessary for the successful implementation of automatic enrolment and whether any rule changes should be introduced to improve its operation.

Changing the thresholds

The main variations to the auto-enrolment regime proposed in the report are detailed in the box below. One of the major changes is the raising of the income threshold for inclusion in the regime to the same amount as the personal income tax allowance, currently £7,336 a year. The original threshold was £5,035. The review team has made the recommendation because of its concern that the lowest paid would not be much better off by saving for a pension once the basic state pension and pension credit is taken into account. The paper argues that there could be a case for raising the threshold to as high as £14,000 a year. However, it concludes that it is preferable to have a relatively low threshold so that those low earners who would benefit from pension saving are not excluded.

The review team also decided that it would be preferable to separate the eligibility threshold for auto-enrolment from the bottom of the contribution band. Once individuals have been auto-enrolled they would continue to contribute unless their earnings fall below the national insurance contribution threshold (currently £5,715), provided they do not opt out. Individuals whose earnings fall between the two thresholds would have the right to opt in and receive the benefit of employer contributions.

The review team was not persuaded that the age thresholds for auto-enrolment should be changed. It was satisfied that the age limit of 22 was appropriate but had some concern about the upper age limit for inclusion (the state pension age) as older people may not benefit from saving for a short period. On balance, however, the team decided it would be better to keep the upper age limit at this level.

No employer exclusions

There were calls during the independent review process for the smallest employers to be excluded from the scope of the auto-enrolment regime. The review noted that around 800,000 employers have fewer than five employees and recognised that the inclusion of these employers in the system will impose a range of obligations on them that they may not have previously experienced and will also present a "major logistical, regulatory and enforcement challenge".

Having carefully considered the alternatives the review team concluded that it would be better not to exclude small employers. Its main reasons were:

• if it did so, 1.2 million workers would be excluded from automatic enrolment;
• there would be enforcement difficulties as employers sought to hide or distort the true number of their employees; and
• it would create a significant disincentive to business growth.

It stressed that it only reached this conclusion because it considers that Nest will provide a scheme that is appropriate to most small employers. The team added that there should be a concerted communication exercise to convince small employers that Nest will be suitable for their needs and to help them understand their obligations.

Reducing the employers' burden

At the same time, the review team recognised that the auto-enrolment regime may impose significant regulatory burdens on employers, particularly those that currently do not offer pension provision. Therefore it proposed a number of regulatory changes. The first is that employers should be able to operate a waiting period of up to three months, which would exclude the large numbers of workers who leave soon after their employment commences and would also allow employers to align enrolment dates with their payroll systems. However, eligible workers would still be able to opt in during the waiting period. The team concluded that the wording of the legislation precludes the possibility of individuals opting out before they have been automatically enrolled.

The paper also proposes easing the rule whereby individuals who opt out must be re-enrolled after three years. It suggests that employers should have three months' flexibility either side of their scheduled re-enrolment dates in which to act to allow them to choose a time that suits their business. However, it rejected proposals that the re-enrolment period should be extended to five years on the grounds it would weaken compliance with the regime.

The paper also proposes simplifying the self-certification procedure for schemes to demonstrate that they have contribution rates that meet the minimum requirement. As originally designed, auto-enrolment requires minimum contributions to be based on a different definition of pay from that used by most pension schemes. The review suggests that the system would be simpler to operate if schemes were allowed to certify that they met the minimum requirements provided they meet one of three criteria, namely if contributions are a minimum of:

• 9% of basic pay including a 4% employer contribution;
• 8% of basic pay including a 3% employer contribution, provided basic pay constitutes at least 85% of the total pay bill; or
• 7% of pensionable pay including a 3% employer contribution, provided that the total pay bill is pensionable.

Retaining Nest

The review team concluded that the retention of Nest is necessary for auto-enrolment to operate on the scale and to the timetable envisaged. If Nest were abolished the team believes that auto-enrolment would have to be dramatically reduced in scope, probably by excluding employers with fewer than 20 employees and excluding jobholders earning less than £14,000 a year.

In reaching this view it considered a number of alternative scenarios and also looked at the experience of other countries of auto-enrolment and national savings plans, particularly Australia, New Zealand, Sweden and Denmark. It found that the models used in these nations would not be suitable for the UK, mainly because differences in the size of these countries' populations compared with that of the UK means that the UK market would not be able to deliver the desired outcome on the scale proposed.

However, the team does recommend a number of policy changes that it believes should be considered in the context of Nest. The first is that the current limit on contributions, originally set at £3,600 a year in 2005/06 terms, should be removed in 2017 once the staging-in of employers to the auto-enrolment regime is completed. It also believes that Nest should be able to receive and make transfers so that individuals can more easily move their pension pots with them when they change jobs, if they wish.

Wider pensions changes

The review team also offers a number of suggestions for reform that do not strictly fall within its remit. In particular, it comments on the differing treatment under trust-based and contract-based schemes of individuals who leave early. People who leave with less than two years' service under trust-based schemes are entitled to refunds of contributions. Those who stay longer in trust-based schemes also receive more favourable commutation treatment for small pension pots than members of contract-based schemes. The paper recommends that the Government resolve these differences as a matter of urgency.

The team also recommends that government reviews urgently whether the existing regulatory regime for defined contribution workplace pensions is appropriate for the "post-automatic enrolment world".

The Government has indicated its support for the review team's conclusions so employers can now start planning for the future.