Pay and Benefits

With the spectre of pensions auto-enrolment looming large on the 2012 horizon, both the employee share plans industry and – perhaps more importantly – the pensions industry are once again having to assess how they can best co-exist. There has long been a connection between the two, not least because they are often vying for the same precious portion of an employee’s disposable income. While a more balanced view might suggest they also have complementary features, it is impossible to ignore the fact that they are different investment vehicles designed with different purposes. At their heart, share plans are a relatively short-term investment to achieve a capital gain, while pensions have always existed as a long-term investment for income. Although both can comfortably co-exist, saving into one is sometimes at the expense of the other. So how will this uneasy relationship survive auto-enrolment?

When the 2004 Finance Act changes to pensions eventually came into force on A-Day in 2006, the connection between the two benefits was cemented with the advent of the Self-Invested Personal Pension (SIPP). It was now more tax efficient and easier to transfer the proceeds of your share plan participation into a pension vehicle, and the choices between investment for capital and saving for income sat comfortably together. Increasingly, employees have been both willing and able to blend the two benefits and in many cases, use the considerable wealth they had accumulated within their share plans to plug the gaps they had in their retirement provision. This was not necessarily via a pension plan but sometimes through more flexible investments, like Individual Savings Accounts.

So has the all-too-brief era of plans and pensions as relatively cosy bedfellows come to an end? To understand that, it’s important to understand the extent of the impact of pensions auto-enrolment on not just the purse of the individual, or even the purse of the company, but also the impact that the legislation will inevitably have on the culture of employee investment and saving.

Auto-enrolment means that all employees aged between 22 and the State Pension Age (SPA) will have to be auto-enrolled if they have earnings above the auto-enrolment threshold. As we’ve come to expect, such legislation always comes with nuances and caveats, but that shouldn’t detract from the noble core principle which is simply that everyone should have some kind of provision for their retirement. Whether or not requiring companies to automatically enrol their employees into a pension will ultimately resolve the issue of millions of people currently without a retirement provision, remains to be seen and can probably only be judged over a significant period of time. What is clear, however, is that the introduction of auto-enrolment is a necessary step that was taken to address a voluntary process that was obviously failing. The Department for Work and Pensions (DWP) estimates that by 2050 there will be one pensioner for every two workers in the UK. Even before these times of austerity, many employees appeared to be making the decision to retain disposable income rather than plan for their future retirement.

The core detail of the auto-enrolment legislation is fairly simple. All employees within the age bracket mentioned above must be auto-enrolled if they have earnings above the qualifying threshold. Employees who don’t quite sit within the age bracket are entitled to opt in if they wish. However, if their earnings are below the threshold there will be no requirement on the employer to contribute to the scheme. This detail appears on the face of it to be fairly simple. Indeed it is, but much of the potential conflict with employee share plans lies in the implementation and impact on both employees and employers.

First among these areas of potential conflict is the cost to the employer of implementing auto-enrolment. Estimates vary wildly on the amount the introduction of auto-enrolment will cost companies. Figures range from £2 billion to £10 billion or more per year being quoted. What is certain is that there is a significant cost, and not necessarily one that companies in a difficult economic climate can easily bear.

There are perhaps ways to mitigate against these large sums and salary sacrifice is potentially a method of doing this. Taking pension contributions from gross pay would have the advantage of reducing tax and National Insurance liabilities and for some schemes the savings to the employer might even make the scheme itself very cost efficient to administer. However, historically and again, particularly against the backdrop of a less hospitable economic climate, there has been a perception that salary sacrifice is not particularly attractive to employees. So the budget has to be found from somewhere and it’s likely that it could be at the cost of other employee spend.

This may bring share plans back under the spotlight and while many Share Incentive Plans (SIPs) are still cost neutral to the employer, the perception of the Save as You Earn (SAYE) plan has been impacted by the introduction of International Financial Reporting Standards. This is because companies are now having to attach a cost to the profit and loss where previously there was none. This has caused some to question the value of such plans. While they are still enormously popular with both employers and employees alike, a further squeeze on employee benefits budgets, such as that provided by introducing auto-enrolment, might force some to re-evaluate. However, a pure cost analysis would miss the “softer” benefits that all employee plans bring, such as engagement and alignment with shareholder interests, recruitment and retention of staff, reward and motivation, as well as longer-term wealth creation.

There will also inevitably be the question of employee appetite with many families now being in a worse financial position than 12 months ago. Although share plan uptake rates have remained fairly stable for a few years, with many companies actually seeing increases, this has always been against the landscape of voluntary pension participation. Again, estimates vary wildly on the level of pension scheme opt-outs that occur from less than 10 per cent to more than 25 per cent depending on industry sector. Even assuming a higher level of opt-outs, there is little doubt that pension participation will increase. Only time will tell whether this increase will impact take-up of share plans. Although it undoubtedly could, historically the continued growth of SIP and SAYE against a series of potentially limiting changes, would suggest otherwise. While many people are struggling with debt, there has been an increasing awareness about saving for protection against economic uncertainty. This has shown itself with participation rates, particularly for SAYE which appeals more to those lower taxpayers with lower risk appetites.

Furthermore, despite the fact that automatic participation in a pension plan is likely to have a noticeable impact on the payslip of a sizable chunk of the population, history and experience of employee engagement would suggest that apathy towards positive action is likely to mean that many stay enrolled regardless of their initial intention. Is it here that another vagary of auto-enrolment will play a significant part? When pulling together the detail of auto-enrolment and pensions reform it would appear that fairly early on in the process that as this was likely to be a costly process for employers, many might seek to offer their employees an inducement to opt out. As this was counterproductive to the aim of the changes, a number of measures are in place to ensure that this doesn’t happen. Specifically, the auto-enrolment documentation and information that employees receive must be free from distraction or inducement, with an expectation that this will be policed with a zeal not previously demonstrated by the DWP and The Pensions Regulator (TPR). While this might have the unwanted side effect of stifling some share plans communication (or at least hindering the timing), a more worrying impact is that it effectively removes the ability to properly financially educate employees. This would enable them to better understand the ramifications of their decision to either remain part of the pension plan or opt out.

It is short sighted to suggest that all of the circa seven million employees not currently part of a company pension plan would be best financially served by joining one. Within that number there will be seven million different personal financial scenarios and it is impossible to conceive that some might legitimately be better served making a short-term investment for capital gain rather than a long-term saving for retirement income. It is therefore a dangerous step to take to hinder the presentation of financial alternatives, albeit if the intention is ultimately a good one.

It’s clear that the world of employee benefits is changing and many would say for the better. There is greater choice for the individual now than there has ever been and as a result of auto-enrolment a huge number of employees who might not otherwise have done so will at least be forced to consider their retirement provision. Share plans have, in turn, faced a number of challenges – both economic and regulatory – but have remained a constant and valued part of the employee benefits offering. Therefore, there is no reason to suspect that both don’t hold a significant place in the future benefits landscape. A key to maximising the value of both, however, may lie in the relationship between the two.

A more in-depth analysis of the pension pots individuals are likely to accrue, purely as a result of their auto-enrolment, shows that the value is not necessarily significant and for many is unlikely to provide a “comfortable” retirement. Instead it’s possibly better for those new to a company pension to understand auto-enrolment as the genesis of a retirement provision and a welcome nudge for many to start thinking proactively about what the future might hold post employment. Within this framework, share plans certainly have a part to play and perhaps a part that has until now been underused. Certainly some employees and employers have embraced the concept of the SIPP plan as a way of enabling employees to have their cake and eat it. The SIPP enables those who built significant wealth in their share plans to use it to protect their future but as with everything, the level of knowledge and understanding of the individual is crucial. Successful financial education could be paramount in ensuring a collaborative future for share plans and pensions post auto-enrolment. However, it remains to be seen whether the DWP and TPR will allow this education to develop in the way it should.

Phil Ainsley is Director of Employee Benefits at Equiniti