Pensions can be a major problem for charities, so click on the headlines below for articles on how you as a charity employer can save money, tackle the implementation of workplace pensions and cope with other pension challenges.
Click on the headlines of your choise to read the articles
As financial pressures on charities continue to pile up it is understandable that employee benefits will be scrutinised for possible savings. Thus the recent judgment in IBM (UK) Holdings Ltd v Dalgleish will be of interest to charity employers. The judgment considered an employer's duty of good faith and the role of that duty when ceasing benefit accrual, when asking employees to agree that future salary will not be pensionable, and when consulting with employees.
As well as examining the role of the duty of good faith in these three instances, this article will consider the new and controversial concept of a member's "reasonable expectations", and, separately, whether the final salary link remained when the employer ceased accrual by exercising the exclusion power.
SEPARATION OF THE "IMPERIAL" AND CONTRACTUAL DUTIES OF GOOD FAITH. The judge, Justice Warren, held that there are two implied duties of good faith owed by an employer towards its employees, and that these duties must not be conflated (i.e. merged):
1. The general duty of trust and confidence arising under a contract of employment.
2. The "Imperial"duty of good faith which applies to an employer's exercise of its powers under a pension scheme (Imperial Group Pension Trusts Ltd v Imperial Tobacco Ltd 1991).
Both forms of the duty should be considered prior to making an amendment to a pension scheme as both duties may be relevant, depending on the context.
TEST FOR BREACHES OF BOTH TYPES OF GOOD FAITH. The duty of good faith will only be breached if the employer's conduct is so bad that it is "irrational or perverse". The IBM case established that this means that an employer could not, in good faith, act in a way in which no reasonable employer would act.
REASONABLE EXPECTATIONS - A NEW TYPE OF RIGHT? It was accepted by both parties in IBM that a promise to a member may have contractual effect; and if a member makes a decision based on a representation which turns out to be untrue, the member may have an action in misrepresentation.
Neither of these scenarios applied in IBM. Rather, the existence of what might be called another type of right was mooted. One of the core issues was whether statements made by IBM engendered "reasonable expectations" in members as to the future of the pension scheme, and if so, whether IBM could act in a way which was contrary to them.
The judge decided that if an employer makes a statement of intention relating to the future, this may restrict the employer's future actions even if it does not amount to a cast-iron promise or a guarantee. This was referred to as a member's "reasonable expectation". Because they relate to the future, the breach of the Imperial duty occurs not when the statements are made, but when the employer seeks to act against them.
IBM was concerned that this elevated non-contractually binding statements into something with legal power. The judge recognised that this was the effect, but considered that it demonstrates the purpose of the Imperial duty – to step in where other remedies are not available - and considered that the existence of a reasonable expectation is highly relevant in deciding whether or not an employer has breached the Imperial duty of good faith.
The evidence required to establish the existence of a reasonable expectation consists of a clear representation made to the general body/ group of members. Evidence from individual members is only relevant to establish what was actually said, and how it was said, and to establish what members' typical level of understanding about pensions matters would be.
Justice Warren concluded that IBM had engendered reasonable expectations in members in relation to:
(i) Future service: benefit accrual would continue unless there was a significant change in financial and economic circumstances.
(ii) Past service: a member would be able to take advantage of the early retirement policy until 2014, unless there was a relevant justification for a change in policy.
If IBM were to act contrary to these reasonable expectations, e.g. by closing to accrual, it needed to have a good reason.
BUSINESS JUSTIFICATION. Any reasonable employer would take such reasonable expectations into account, and balance them against the business need or justification for the changes it was proposing to make.
The IBM judgment made it clear that the existence of a rational business justification is not a silver bullet – the assessment of commercial matters and the making of business decisions are a matter for management, but the existence of a coherent, rational and bona fide business case does not preclude the court from questioning the decision.
In addition, the employer cannot take into account only its own interests – there must be a balancing between the members' reasonable expectations and the employer's interests, in light of all the circumstances of the case.
RIGHT TO FUTURE SALARY INCREASES. The judge confirmed that IBM employees had no reasonable expectation of future pay increases. Nevertheless, an employer which indicates or threatens that an employee will not be eligible for any future salary increases unless they agree that they will be non-pensionable will be in breach of the contractual duty of good faith.
CONSULTATION. It was held in IBM that a consultation exercise must involve an employer engaging with members during a consultation process and giving genuine consideration to any comments or suggestions received from the members. A clear (and honest!) explanation for making the proposed changes must be given.
IBM did not approach the consultation with an open mind as it did not engage with suggestions from members during the consultation. In addition, it was less than upfront during the consultation – it did not give members a clear explanation of why it was really making the changes (namely to reduce pensions expense to meet 2010 global profit targets).
Even though closure was only intended for 2011, it told members it wanted to close the scheme in 2010. Justice Warren considered that this was a deliberate attempt to preserve its negotiating position, and a tactic to persuade the trustee and members to accept the package it was offering.
Regulations governing the consultation process were also considered during the case. There is no remedy for a breach of the consultation regulations themselves in the ordinary courts. Rather, the remedies include complaining to the Pensions Regulator who may issue an improvement notice or a penalty. IBM argued that a claim under the contractual duty of good faith was therefore precluded. The judge disagreed and considered that the breach of the duty of good faith arose from the way in which the consultation was carried out.
Employers would be well advised to create a clear audit trail demonstrating that the consultation process has been properly carried out. It is worth noting that internal communications regarding the consultation process, including advice obtained by the employer (excluding legally privileged advice), will probably be disclosable should the legitimacy of the consultation exercise be challenged.
HOW DID IBM ACHIEVE CESSATION OF ACCRUAL UNDER THE SCHEME? Closure was achieved by ending membership for all active members under a power which provided that the employer could notify the trustee that "any specified person or class of persons shall cease to be a member or members". The judge considered that as the power could be exercised in relation to a class of members it could be used to end membership for all members.
It was common ground that using this power would break the final salary link as the rules stated that final pensionable earnings were fixed when membership ceased. However, the power was not one which was in the original trust deed and rules, but was added to the scheme at a later date. The issue which arose was whether the addition of the exclusion power to the scheme breached a restriction in the amendment power which protected the link to members' final salary in respect of benefits earned up until the date of any amendment.
The judge held that the power was validly introduced, but was subject to an overriding limitation that protected final salary linkage in respect of benefits accrued up to the date of the exercise of the exclusion power. There was nothing objectionable about the plan being amended to introduce the exclusion power to enable IBM to close the scheme to future accrual at a future date, as long as the final salary link was preserved.
WIDER RELEVANCE OF THE JUDGMENT. Whatever the outcome of the appeal against the judgment, the principles arising from the IBM case will need to be taken into account by charity employers in relation to any decisions regarding changes to a pension scheme.
Charity employers may also wish to look back at statements previously made by the employer to the employees and to the pension scheme trustees, and revisit previous decisions - particularly decisions to close a pension scheme to future accrual - to ensure that those decisions did not breach either of the implied duties of good faith owed by the employer, thereby making the decision subject to a potential challenge by affected members.
In IBM the judge suggested that the following could be relevant to a possible breach of the duty and indicative of the possible existence of reasonable expectations:
• Statements made by the pension trustees to the employees based on a message from the employer.
• Employee knowledge that the pension trustees assume that accrual or other benefits will continue and the pension trustees act upon this.
• Assurances from the employer to the trustees which the trustees act upon;
• If the scheme's investment strategy has been agreed as a long term answer to the employer's commercial requirements, this may strengthen any message that a scheme is sustainable and on a firm footing for the future.
The traditional view is that future benefit design is a matter for the employer. Following IBM, does the employer really have a free hand to change future service benefits?
IBM intends to appeal the High Court's decision so please be aware that there may be further developments of the issues raised in this article.
"The evidence required to establish the existence of a reasonable expectation consists of a clear representation made to the general body/group of members."
"...a consultation exercise must involve an employer engaging with members during a consultation process and giving genuine consideration to any comments or suggestions received from the members."
Saving charity employers money on pensions
FROM THE EDITOR: The cost of pensions could be the next "big issue" for the charity sector to face, in relation to both relieving charities of what must seem relentless financial pressure, and addressing what could turn out to be a huge public relations problem with donors questioning why they should be financing charity pensions. The following two articles by a financial advice firm and a major charity show how the operation of a pension increase exchange can make a significant impact in reducing pension costs for charity employers.
Scroll down to read the articles
How a pension increase exchange works for charities
To put things into perspective, in March this year 93% of charities said that they were experiencing a squeeze on fundraising while 67% said that demand for their services had increased, according to a report by accountants PwC, the Charity Finance Group and the Institute of Fundraising.
Meanwhile the aggregate deficit for defined benefit schemes within the Pension Protection Fund is estimated to have decreased to £185.5bn at the end of May 2013, from a deficit of £256.6bn at the end of April. A solution to those charities labouring under the demands of a final salary scheme is a pension increase exchange exercise – or PIE.
In short, according to the Pensions Advisory Service, for the pension scheme member this means: "If you are taking your pension, give up the pension increases set out under the rules, in return for a one-off increase to your pension. If you accept it, your pension is paid at the new rate for the rest of your life, without any further increases."
The way it works is that the charity employer sits down with the pension trustees and agrees the increased pension offer they will make to a member. An offer is made to pensioners to give them a significant increase in their pension now in return for giving up (non-statutory) increases in the future. The increase is often less than the full value of the inflation and longevity risk and so has the effect of reducing the deficit.
An example would be a member with a £10,000 pa pension being offered an increase to £12,000 pa. This amount will not increase in the future, which means that for someone in ill health with a potentially shorter life expectancy, the offer may be an attractive one. However for someone younger and/or in good health the offer may be less attractive.
The obvious potential disadvantage to the member of such an exercise is that they don’t do as well as they would have done under the standard scheme increases. This is more likely to happen if members are not given all the information and advice they need to make an informed decision. The Pensions Regulator has issued guidance to trustees and employers as to how they should manage incentive exercises, as follows:
• Be clear, fair and not misleading.
• Be open and transparent.
• Manage conflicts of interest.
• Have trustee consultation.
• Include independent financial advice for members.
Key to the guidance is clarity and transparency and access to independent financial advice. A number of financial advisers and pension consultants now offer PIE advice services. The adviser will advise each member (should they accept the offer of advice) as to whether it is in their interests to accept the offer or not.
The member doesn’t have to accept that advice. But the advice will be documented in a report to the member so they have all the information and reasons why in front of them. It is key that the adviser covers all potential issues such as health, taxation, inflation, state benefits, assets and liabilities. Plus the life time allowance issues that may affect the larger pensions. This will allow them to advise the member on what is likely to be suitable.
The charity employer will not see this report – it will remain confidential. What the employer will be given is the number of members who have made contact and those who have accepted the offer and the number who haven’t.
There is a cost of course – for the pension consultancy and the independent advice to members. There will also be legal costs because employers and or trustees will need to seek such advice.
But what specifically are the risks to members? For the member there is the risk of loss in the amount of pension benefits they receive in the long run, perhaps because of how long they live. There are many factors that could come into play which can be predicted in broad terms but not insured against entirely.
For the scheme or the employer the pension liability will diminish.
The key to the whole exercise is communication. For the charity trustees or directors it should be recognised that a long warm up time is in order. You will need to communicate to members what it is you want to do and when, and make clear to them that there is independent advice available to them.
Some members are very informed and understand what it all means, some are not, but a good adviser will be able to pitch the advice at the right level for all members.
Tackling a charity pension deficit problem
The scheme was closed to new members and in April 2010 to future accrual. Whilst the latter stopped the deficit growing what was left still had to be dealt with. In 2008 the Legion had begun a recovery plan to bring the scheme into balance in six years and to be sure of this happening the liability had to be removed from the scheme.
It was decided that a pension increase exchange (PIE) was the solution. It was agreed with the trustees that, from the actuarial valuation of the increases given up, 60% would be used to enhance the immediate pension leaving 40% to reduce the deficit. The business case, agreed with the trustees, showed an upfront cost of around £200,000 with an expected take up of between 10% and 15% to yield a deficit reduction of up to £1m.
The first stage of the PIE exercise is to make the offer to eligible pensioner members, i.e. is those with pensions earned before 1997 in excess of the guaranteed minimum pension (GMP).
RBL as the employer, the pension scheme trustees, consultants First Actuarial and LEBC, as adviser to the scheme members, ensured all member correspondence was clear, concise and unbiased. Eligible members received a "warm up letter", which pre-advised them that an offer would shortly be made available to receive a higher pension now, in exchange for giving up future increases on their pension.
The letter gave them the option to "opt out" at this stage but very few members did. A full offer letter was then sent two weeks later and members were asked to contact LEBC’s helpline for free, independent advice.
Following a telephone consultation (supported by a face to face meeting for vulnerable members), each member contacting the IFA was provided with a clear recommendation on whether accepting the offer is in their best financial interests.
The PIE offer is now being developed for future retirees. We are optimistic that the take up from this cohort will be greater. The commutation rate amongst retiring members from the scheme historically is in excess of 90%. Embracing PIE, a retiree will be able to take the commutation and then enhance the reduced pension closer to the original value.
What PIE has meant for us is that some scheme members get a very attractive offer and as a charity we can manage the pension scheme deficit and safeguard its reserves for future beneficiaries.
You cannot escape the adverts. Your charity’s finance officer may already have received the letters; auto-enrolment is on its way. Until recently there was no general legal requirement for employers to contribute towards pension arrangements for their employees. That all changed with effect from 1 October 2012.
In a major departure from existing law, all UK employers will be requirement to auto-enrol certain of their staff into a pension arrangement into which the employer will be required to make contributions. Many charities do not currently provide any pension provision. For all charities, whether large or small, auto-enrolment will have a major impact both on charity finances, and lead to a considerable amount of internal management time and resources needing to be expended in understanding and complying with these new obligations.
Phasing the impact
The auto-enrolment legislation came into effect from October 2012. The Government sensibly decided to phase in its impact so that it applies to larger employers first. As almost 70% of charities have less than 50 staff, this means that their auto-enrolment date, the date the auto-enrolment requirements first apply to them, will likely not be earlier than 1 August 2015 Charities with less than 30 staff are likely to have their auto-enrolment date as far away as 2017.
However, it can take up to 18 months for an employer to complete all the planning stages to ensure compliance, and many charities should be about to begin or have already commenced their planning stage.
WHAT DOES "AUTO-ENROLMENT" MEAN? It is rather complex. However, in simple terms all charities will need to review their staff and establish who are “workers”. This must be done because there are legal obligations on charities in respect to all their workers, even if only certain workers must be auto-enrolled into a pension scheme. There are three sub-categories of workers.
“Workers” generally are individuals who: work or ordinarily work in Great Britain under a contract of employment; are aged over 16 and under 75; are in receipt of “qualifying earnings”. For charities in particular the wide age bands mean that teenagers and the retired are still caught.
The first sub-category, which imposes the most onerous obligations on a charity, relates to “eligible jobholders”. These are “workers” who are aged over 22 and under state pension age who are earning the equivalent of £9,440 per annum or over. From its auto-enrolment date the charity must, automatically enrol all eligible jobholders into an auto-enrolment scheme.
Where the pension is defined contribution in nature, the contribution rates start at 1% employer 2% employee, rising to 3% employer 5% employee by 2017. Such contributions are calculated against banded earnings between £5,668 and £41,450 (those numbers rising with the rise in National Insurance earnings bands).
Non-eligible jobholders also have rights to pension contributions under the legislation if they so elect to participate. A non-eligible jobholder is a worker aged between 16 and 20, or aged between state pension age and age 75, with earnings over £9,440 or someone who is aged between 16 and 74 with earnings above £5,668 but less that £9,440.
While the employer need not automatically enrol non-eligible jobholders it must notify them of their right to be treated as if they were eligible employees. If the non-eligible jobholder so elects, he is entitled to the same level of contributions into the same types of pension schemes as an eligible jobholder. From a charity finance perspective it should be noted that this group means includes the young and those past state pension age.
The methods used to calculate the notional annual salaries referred to above are actually based on actual pay in the relevant pay reference period, i.e. weekly, monthly etc rather than actual annual salary. Therefore any casual employees within the charity sector will be caught even if they only work for part of a year if, during their period of employment, their qualifying earnings during a relevant pay reference period are in excess of the relevant fraction of the notional annual salary, e.g. a monthly salary greater than 1/12 of £5,668 or £9,440.
Jobholders opting out
Eligible jobholders have a right to opt out of the auto-enrolment scheme if they wish. However, the charity cannot do anything during the recruitment process or the employment relationship that encourages eligible jobholders to opt out or non-eligible jobholders not to opt in.
To be an auto-enrolment scheme the pension scheme must have no barriers to joining, i.e. must not require the completion of joining forms, have age limits (outside those described above) and must not require member decisions (such as investment choices).
PLANNING AHEAD. The key issues for charities in the planning stage are as follows:
• What is their auto-enrolment staging date (the date when the requirements first apply to the individual employer)? This date is based on THE number of employees under the charity’s PAYE reference number. A copy of the staging dates can be found on the Pension Regulator’s website as well as other sources.
• How many of their staff are "workers"?
• Which of the three sub-categories of “worker” do the employees fall into?
• Is the charity going to take advantage of the three month postponement period from the staging date?
• Will the charity only enrol new eligible jobholders after its staging date from the date three months after the employee first meets the criteria, as allowed by legislation, or from an earlier date?
• What pension scheme will the charity select as its auto-enrolment scheme?
• What level of contributions will the employer offer, the minimum required or something higher?
• How does auto-enrolment fit into the charity’s wider benefits and rewards package?
• Who within the charity has the time, knowledge and resources to monitor each employee’s changing status between the three sub-categories as their age or as pay change.
WHAT ARE THE OPTIONS AVAILABLE TO MEET THE LEGAL REQUIREMENT? If the charity already has a defined contribution pension arrangement, then depending on the total level of contributions being made meeting a minimum level, this may be sufficient to qualify as an auto-enrolment scheme for those eligible jobholder staff who already participate. If the charity offers a defined benefit pension arrangement then this may again be sufficient for those participant staff so long as the benefits provided are at least equal to a minimum standard.
New scheme requirement
The problem comes with respect to eligible jobholders who do not currently participate in any pension arrangement or who participate in an arrangement that does not meet these minimum defined contribution/defined benefit standards. In this the charity will need to select a new arrangement, no doubt having taken advice from a benefit or other consultant.
In most instances charities are likely to only want to set up a defined contribution arrangement due to the uncertain costs associated with defined benefit pension arrangements. There are various large providers of such arrangements as well as group trust arrangements offered by most of the major insurance companies.
One difficulty that some charities face is how higher pension costs that are brought on by auto-enrolment impact on their ability to fund any existing defined benefit arrangements. Some charities are therefore looking at closing off their defined benefit liabilities, to the extent that they can.
What are the risks? Auto-enrolment obligations come with teeth. Wilful non-compliance can lead to significant penalties from the Pensions Regulator. The more charities plan ahead and take advice from benefit consultants and lawyers, the easier it will be to meet the challenges that auto-enrolment will no doubt throw up.
Rising contribution rates
In the end, many charities only have a limited scope for meeting staff expenses. Charities will therefore need to factor in the ongoing and (from 2017) rising employer contribution rates to establish what impact that cost will have on their ongoing operations.
Anecdotal evidence would suggest that current opt-out rates for employers which have already had their AED (automatic enrolment date) is as low as 10%-15%. Therefore, for a charity with no existing pension arrangements and a large number of eligible jobholders, the eventual 3% employer contribution for 85%-90% of staff could be a material cost.
"Eligible jobholders have a right to opt out of the auto-enrolment scheme if they wish."
"The more charities plan ahead and take advice… the easier it will be to meet the challenges that auto-enrolment will no doubt throw up."
Pensions Minister Steve Webb unveiled the government’s long anticipated flat rate pension plans in January. The minister said in his statement in the Commons that the new scheme is a single, simple and decent pension which is expected to start from April 2016.
The current basic state pension is £107.45 per week for an individual who has made National Insurance (NI) contributions for 30 years. This can be topped up by pension credits and additional state pension. The new flat rate pension proposal is for £144 per week in today’s money, plus inflation rises between now and 2016.
The current qualification for a full basic state pension for a retiree is making 30 years worth of NI contributions. Under the new proposals, people will have to make contributions for 35 years in order to receive the full £144 per week in pension payments; people will have to work longer in future. The minimum contribution period is 10 years under the new scheme. Anyone with less than 10 years of contributions will not qualify for pension at all.
The plans for a flat rate pension are a bold attempt to reform the current system of different state pensions plus tax credits into a single pension. Just one, single state pension available to all retirees based on the number of years of NI contributions paid over their working lives.
The current system comprises a basic state pension of £107.45 a week for an individual and £171.85 for couples, if only one of them qualifies for the full basic state pension. To qualify for a full basic pension, a person has to have made 30 years worth of NI contributions by working or being credited caring for a family or by making voluntary payments to make up the missed years.
In addition to the basic state pension currently, there is an additional state pension of (i) the second state pension (S2P) or (ii) the state earnings related pension (SERPS). A further element is the Pensions Credits – a means tested benefit that guarantees a minimum weekly income of £142.70 for a single pensioner and £217.50 for couples.
The plans for the new flat rate pension are certainly simpler; mind you "simple" is very different from "fair"! As with any changes, you would expect to see some winners and some losers. Indeed, the Government has claimed the new proposals are cost neutral.
The clear winners are the self-employed people. They currently do not qualify for the additional state pension and receive the basic state pension. They will qualify for the whole flat rate pension under the new plans. Couples where both have 35 years of qualifying contributions will get £144 each or £288 between them.
Women and carers will also be better off under the new system. People who do not make enough contributions due to intermittent work patterns and periods of low earnings have been worse off under the current system since they have not benefited from the additional state pension.
The clear losers are high earners who will not get any additional state pension under the new system. Also losers are workers who are currently contracted-out of the second state pension – those in the public sector and private sector members of defined benefit pension schemes. These employees and their employers will have to pay the full NI contribution rates in future, rather than the lower contracted-out NI rates currently.
Everyone will need to make contributions for 35 years rather than 30 years under the current system. The minimum qualifying period will be 10 years. Currently, one can build up a state pension from just one year’s contribution.
In order to comment on a "decent" pension one needs to ask, decent for who? £144 a week is a decent rate for most people who will retire after April 2016. It is worth remembering there are millions of pensioners, mainly women who currently receive far less than £144 per week. All the pensioners under the current system will not benefit from the new higher flat rate of £144 a week.
It is a decent rate for people who have to currently rely on means testing to get pension credits in order to enhance their pensions. Under the new scheme there will not be a means test. There also an estimated million plus pensioners who miss out on pension credits. In future all pensioners will receive the new flat rate pension of £144 a week – provided they have made contributions for 35 years.
The charity sector employs a higher proportion of women compared to men. There are a significant number of part-time workers in the sector. Most experts are of the view that such workers will be better off under the flat rate pension scheme. They will be entitled to a flat rate pension of £144 per week rather than the current basic pension of £107.45 a week. However, the qualifying period will increase from 30 years to 35 years.
The big impact will be on those charity employees who are lucky to be in the defined benefit salary scheme. They and their employers too will have to pay a higher NI contribution under the new plans. The lower contracted-out NI rate will not be available to them. The cost of NI rebate to the employer will be 3.4% and the employees’ NI contribution rate will go up by 1.4% of relevant earnings. It is estimated that employees could see a reduction of £300 in their pay per annum a year on average.
The new scheme will not apply to anyone who reaches the pension age before April 2016. As would be expected the Government has transitional arrangements for those people who become eligible for the state pension after April 2016. The provisions are rather complicated and potentially subject to revisions as the Bill goes through Parliament. Generally, the plan is to determine a "foundation amount" at the point the new pension is introduced based on the NI contributions to that date. The pension will be higher of;
• The state pensions accrued under the old system.
• The new state pension accrued, less an amount to reflect past periods of contracting out.
Thus it is hard to argue against simplification of the current system, which is a minefield to navigate and forecast. However, as the Government’s proposal is intended to be cost neutral and have some winners, there will inevitably be losers.
Much of the media attention on this has focused around the plight of hard-pressed employers and their staff having to afford yet another demand on their diminishing income. Whilst this perspective is understandable in a time of recession, the view of many is that mandatory pension contributions are a GOOD thing. Clearly this is the Government's thinking behind the new legislation.
There have been many institutions which have long campaigned for pension contributions to be made mandatory. The current pre-retirement generation has been driving hard into the sunset of their retirement – but the tank is running on empty.
The issue is: many of us will not benefit from the defined benefit pension schemes of our parents’ generation and the state cannot afford to provide for us via the state pension. It is down to us to plug the savings gap and fund for our own retirement.
This is a steep hill to climb. Try counting up the pay days you have until your intended retirement age and that’s the number of opportunities you have to set aside some savings to provide you with the income you need for the remainder of your life when you retire. People are living longer so even more resources are needed to fund the retirement gap.
The good news is that the earlier you start to save, the bigger impact you can make upon this gap (because of compound returns). For example, saving £200 per month over a 40 year period with a 7% annual rate of return will produce a fund of over £500,000. But it is a sobering thought that if you wait 5 years to start you must increase your monthly saving by 50% to £300 – or your pension fund will only just exceed £350,000!
Pensions Minister Steve Webb says he hopes the new auto-enrolment scheme will mean millions of people will start saving for their retirement. In the radical shake-up of workplace pensions, taxpaying workers will be automatically enrolled in their work's pension scheme. The new scheme has the support of the TUC.
So what about the charities, including care charities, which will have to fund a proportion of the contributions into these pension schemes for their employees and workers? With continued pressure on costs and more regulation on employment, is there an opportunity or advantage to the charity employer concerning the new pension provision costs?
Rather than charity employers concentrating on the negative impact around the cost of employment increasing, can the issue be turned on its head?
Concentrate on the fact of pension payments by your charity as an incentive to recruitment. With charity care homes, for example, there appears to be a shortage of good staff, so why not use this as an opportunity to advertise how good you are as an employer by making it clear that you pay into your employees pensions are concerned about their future.
The charities which will attract the best care staff are those which offer the best packages and show that they have the best interests of their staff at heart. The knock-on effect of happy staff is obvious – commitment to the job which in turn delivers better standards and improves the performance of the charity, making it more attractive to the clients and donors.
Managed in this way, as a huge benefit to both existing staff and attracting new staff in the future, the auto enrolment loses its sting and instead becomes a positive tool for staff retention, recruitment and best practice.
The problems faced by charities who are participants in multi-employer schemes has recently been highlighted by the decision of the High Court last December in a case involving the Wedgwood Museum. As a result of the decision the Wedgwood Museum’s collection built up over three centuries by Josiah Wedgwood and his family will have to be sold. The collection is of great historical and cultural significance and there is already a campaign underway to attempt to preserve the collection.
Whilst the case raises many issues about the effect of pensions legislation and whether the “last man standing” approach is appropriate in the charity context another equally important issue is whether the problem could have been avoided. To explain this, we need to understand the background to the case.
THE RISE AND FALL OF THE WEDGWOOD MUSEUM. The collection was originally accumulated by the Josiah Wedgwood family and, over time, became an asset of Josiah Wedgwood and Sons Limited which was the main trading company. During the 1960s the trading company decided that it would be appropriate for the collection to be placed into separate ownership. This was to ensure that any economic misfortune experienced by the trading company would not result in the collection being treated as an asset of the trading company causing it to be sold off to pay its debts.
As a result, in 1962 a separate charitable company, Wedgwood Museum Trust Limited (“Museum Company”), was incorporated and the collection was gifted to the Museum Company in 1964. At the time it was considered that the incorporation of the Museum Company, as opposed to setting up a trust, would afford greater administrative flexibility whilst still allowing the Wedgwood family to retain ultimate control. The main intention of its incorporation, however, was to ensure that the collection was held in perpetuity.
At a later date those staff of the Trading Company who ran the operations of the Museum had been formally transferred to the Museum Company. The most significant implication of this move was that the Museum Company agreed to become a participating employer in the group pension scheme so that the transferring staff could stay in the group pension scheme.
The Trading Company subsequently went public and, in time, became part of the Waterford Wedgwood Group. In the aftermath of the credit crunch the Waterford Wedgwood Group went into administration in January 2009.
When the group went into administration in 2009, a pension deficit was triggered in the group pension scheme. The group pension scheme had been set up as a pooled scheme in which all participating employers had a notional entitlement to a share of the fund and, crucially, the liabilities.
Last solvent employer
The consequence of such a scheme is that, ultimately, in the event that any of the participating employers become insolvent, their unpaid liabilities are shared across the other employers until you get to the “last man standing”. (This is different to a multi-employer scheme were the fund is segregated and each employer has distinct assets and liabilities allocated to them.)
The problem faced by the Museum Company was that when the rest of the group went into administration, it became the last solvent employer in the group pension scheme. The Museum Company therefore became liable for the entire deficit on the group pension scheme. This was despite the fact that the museum itself only employed five of the total 7,000 employees in the group. The deficit in question is £134.7 million.
Had the group pension scheme been a segregated scheme, then the Museum Company would have faced a liability of approximately £100,000, which would have been more than covered by the Museum Company’s assets (the collection being estimated to be worth £18 million). As this had not been the case, however, and the Museum Company’s liability was unlimited, the entire debt fell squarely on the shoulders of the Museum Company, thus forcing it also into insolvency.
Whether an asset
The joint administrators of the Museum Company made an application to the High Court to determine whether the collection, estimated to be worth up to £18m, could be considered an asset of the Museum Company and therefore sold to pay off creditors or whether it was protected in some form as its donors had intended.
THE OWNERSHIP OF THE COLLECTION. The key question that the court had to determine was whether the collection was the beneficial property of the Museum Company, or whether it was held by the company subject to special trusts. If the former was the true position, then the assets would be available for distribution to the creditors to satisfy the pension liability.
If, however, it was deemed that the collection was gifted by the Trading Company to the Museum Company to hold as trustee of a special trust, it would not be available for distribution to the creditors, as the Museum Company would merely be the trustee of the collection.
When the collection was gifted to the Museum in 1964, the documentation did not reflect the subjective beliefs of the trustees of the Trading Company that the collection would be held as a permanent and inalienable collection.
Held on trust
The deed of gift stated that the collection should be "[held] on trust for the Wedgwood Museum Trust Limited", but whilst it can be seen that reference to a trust is clearly made, a separate charitable trust was not identified and the High Court held that the collection was therefore not taken outside the ownership of the Museum Company but was an outright gift to the Museum Company.
Under the terms of the deed, the Museum Company held the collection for its charitable purposes, namely for the establishment and operation of the museum. There was nothing in its objects which supported the idea that the museum was to acquire the collection upon a charitable trust and become the trustee of the collection, as opposed to the beneficiary of it.
The High Court ultimately held that there was no evidence of a special trust. Although it was recognised that the assets of a charitable company are normally held for the purposes of fulfilling the objects of the charity, as set out in its Memorandum and Articles of Association, once the company goes into insolvent liquidation, its general purposes change and are governed by insolvency legislation. It is under this remit that the collection of the museum was available for distribution to the creditors to satisfy the pension liability.
HOW COULD THE PROBLEM HAVE BEEN AVOIDED? Whilst a charitable company cannot hold assets as permanent endowment, as such, it is possible to replicate the same outcome by ensuring that the asset in question is held by the company as a trustee of a special trust. Had the collection been gifted to the Museum Company to hold as the trustee of a special trust then, in the current circumstances, the Museum Company’s only interest in the collection would have been as trustee, and it would not have been an asset that fell into the general assets of the Museum Company.
Alternatively, the problem could have been avoided by ensuring that the group pension scheme was set up as a segregated scheme, so that the debts of one employer did not flow through to the other employers in the scheme.
COULD THE POSITION HAVE BEEN RECTIFIED? Under the museum’s Memorandum and Articles of Association, it was, in fact, open to the Museum Company to support and establish other charities. It would therefore have been within the Museum Company’s power to establish a separate charitable trust for the purpose of holding the collection and to have transferred the collection across to the new trust.
However, whilst on the face of it this sounds an attractive solution, the anti-avoidance provisions of both pensions and insolvency legislation would actually have prevented this from having been successful.
Under insolvency legislation, if the collection had been gifted to a new charitable trust, then this would have been viewed as a transaction at an undervalue and could, in the event of the Museum Company going insolvent, potentially be undone.
Under pension legislation there are specific provisions that are intended to prevent the employer from moving assets so as to avoid its liability under a pension scheme. This is known as the “moral hazard” risk. Essentially the Pension Regulator can exercise its powers to seek financial contributions from those involved in acting or failing to act in such a way that is materially detrimental to the members of the pension scheme.
There is therefore no easy solution once the problem has been created, as whichever path is taken ultimately comes up against legislation designed to impede its success.
ANOTHER WARNING. This no doubt serves as yet another warning to all operators of museums and galleries which have long standing collections that were intended to be permanent. It would be diligent for those operators to thoroughly check their legal documentation to ensure that special charitable trusts have been created.
If they have not been, then they should take professional advice as to what steps, if any, can be taken to ensure that the collection remains protected in perpetuity if there is a lingering pension debt in the background. If no solution can be found, then those museums and galleries concerned must hope they are not the “last man standing”.
"When the group went into administration in the first place, a pension scheme deficit was triggered in the group pension scheme."
"The problem faced by the Museum Company was that when the rest of the group went into administration, it became the last solvent employer in the group pension scheme."
"The joint administrators…made an application to the High Court to determine whether the collection…could be considered an asset…and therefore sold to pay off creditors…"
"There was nothing in its objects which supported the idea that the museum was to acquire the collection upon a charitable trust and become the trustee of the collection…"
The pensions task for charities
FROM THE EDITOR: The last thing charities want to be distracted by right now is the task of having to offer some kind of pension provision for their employees. It is not just the time and effort required but also the cost which will have an impact on charity finances. However, it is not a task which will go away. It is compulsory. Even if employees want to opt out you still have to go through certain procedures.
This feature is designed to focus the minds of charities on the workings, requirements and implications of the new compulsory pension arrangements. There are six commentators participating in the discussion below: Joe Bates, John Harrison, Heather O'Driscoll, Stephen Nichols, Michael Garvey and Andrew Rackham.
It is hoped that when you have read all six contributions your charity will at least be prepared to adopt the right mindset to deal with the pensions task – and sooner rather than later – indeed immediately. Charity employee pensions must now be a priority.
Not a perfect pensions future
JOE BATES of accountancy firm CLEMENT KEYS comments: As employers, charities are no different from any other employer in that they will fall into the new regulations which the Government is introducing to ensure that everyone has some pension provision. These will place duties on charity employers to automatically enrol employees in a workplace pension scheme. For ease, charity employers can use the National Employment Savings Trust (NEST) or, if they prefer, they can either set up or use an existing qualified pension scheme.
The regulations are due to be introduced from October 2012 but this will only be for the largest employers. Those employing between 50-249 people will be allocated a start date between 1 April 2014 and 1 April 2015 and small employers will be allocated start dates between 1 June 2015 and 1 April 2017. The plan is that the Pensions Regulator will write to all employers at some point in the year before their due start date so that they know when they will have to automatically enrol their employees.
The minimum contribution has been set at 8% of "qualifying earnings" but this will only take place from October 2018. Of this, the charity employer will be expected to contribute 3%, the charity employee 4% and tax relief will be contributed at 1%. Before that, the minimum will be 2% overall within 1% minimum from the employer until September 2017, and between October 2017 and September 2018 the minimum will be of 5% with 2% from the employer.
The employer may choose to contribute more than the minimum level in which case the employee will be able to reduce their contributions accordingly. In any event, employees will be able to opt out of the scheme if they wish but the employer will not.
As stated above the Government is introducing a simple low cost option known as NEST which is designed to enable employers to comply with the regulations in a low cost easy manner. The charges will be 1.8% on funds going in and .03% annual charge on the value of the fund. The maximum contributions which may be made for a member including tax relief has been set at £4,400 for 2012/2013, and funds may be invested in a choice of five funds, being lower risk, higher risk, sharia, ethical and pre-retirement funds. Funds invested in NEST will be fully portable in that employees will be able to take them from job to job.
As stated above, charities will be no different from any other employer in having to comply with the new regulations but will probably find the administrative burden proportionally greater than some larger commercial employees. Therefore it is important that charity employers anticipate the changes and how these are going to affect their individual charity, and make sure there is a suitable plan in place to implement them.
A burden for charity employers
JOHN HARRISON of actuarial and consulting firm BARNETT WADDINGHAM comments: The recent leak of a report from the Association of Chief Executives of Voluntary Organisations (ACEVO) spelling out funding cuts to the charity sector will be no surprise to those involved in the financial affairs of charities. For some time the economic climate has been hitting charities hard. The government has set out on a plan to significantly reduce the country's budget deficit, and those charities reliant on government funding face severe reductions to their income. In addition, many households are experiencing an unprecedented squeeze on their disposable income. Income from donations for all charities is likely to be hit just as hard. This comes at a time when the demand for charity services is increasing.
I have a good deal of sympathy with employers which have sponsored a defined benefit pension scheme, especially those employers in the third sector. Many schemes were set up at a time when the rules of engagement were very different to what they are now. Over the years, there has been significant improvement of both the level of benefits that schemes must provide and the protection given to scheme members. All of this is very laudable but has come at a price. There is little point in having the best protected pension system in the world when there are no decent pension schemes!
When things go wrong it is employers who are the ones that pick up the bill. They can change the level of benefits provided going forward and also ask their current members to increase their share of the cost. But they have to ensure that benefits built up to date by current employees and benefits earned in the past from former employees can be provided in full. So often it is this commitment which dramatically affects the ongoing viability of an organisation. For charities, in the current climate this burden might be too much.
JOHN HARRISON of BARNETT WADDINGHAM continues: There is no safety valve for employers. Historically, it was common for pension schemes to plan for a degree of protection against inflation when benefits come into payment but before legislation made pension increases mandatory (even though having a pension scheme has never been mandatory so far) if the scheme's finances were unable to afford increases they weren't granted. It is precisely this type of flexibility that employers are crying out for.
The last thing that charities need at present is their costs to be increasing even further because of a projected rise in the cost of providing pensions. Yet this is precisely what many charities will be facing – a perfect storm. Those with their own defined benefit scheme will be questioning their ability to continue providing benefits in their current form. This will be a highly emotive subject to raise with workers, but the reality is that the status quo is not an option.
Workers will have to recognise that if the charity is to continue in the longer term then pension scheme provision has to be at a level which not only is fair to them but comes with acceptable levels of risk and cost to the charity. Those charities participating in the Local Government Pension Scheme will be aware that the Government realises that the current scale of benefits is unaffordable over the longer term.
JOHN HARRISON of BARNETT WADDINGHAM says: A key reason why defined contribution pension schemes (where contributions are fixed but benefits unpredictable) are viewed as inferior is the low level of contributions that are paid into them. Often when employers move away from defined benefit provision to defined contribution provision they see this as an opportunity to cut costs at the same time and "you can't get a quart out of a pint pot". This switch to defined contribution is currently a runaway train. In due course there will be a significant number of people retiring from defined contribution schemes on income below subsistence level but until then this is unlikely to change.
There is no middle ground, and this is the problem. Until pension legislation allows employers to provide their employees with a desired level of retirement income with the ability to moderate it when necessary due to, for example, increasing longevity, then employers will continue to stop providing defined benefit pensions. Those charities which are still to make this leap should make sure that the level of contributions is expected to be sufficient to provide a reasonable level of retirement income. Whilst there are many other elements to the design of a good defined contribution scheme, a level of contributions which can generate a reasonable level of retirement income is an essential starting point.
The pensions dilemma for charities
HEATHER O'DRISCOLL of accountancy firm WALTONS CLARK WHITEHILL comments: The introduction of new pensions legislation creates a major dilemma for charities; not to mention a further drain on financial resources at a time when they can least afford it. "Auto enrolment" will mean that charities, just like any other business, must pay towards a pension for all employees who do not opt out of the scheme. Charities can scarce afford such an increase in costs at the best of times, let alone when they are being squeezed by the wider economic problems of many donors.
By bringing in auto enrolment and not excluding charities from the same obligations as other employers this means that money donated to charities may be spent on the pensions of those who work for the organisation rather than on frontline services. Those who donate to charity see in their mind an end cause and will undoubtedly never consider their "gift" is potentially going into the pension fund of an individual behind a desk in an office around the corner – no matter how valuable that person's role.
Employers are told they should not actively encourage employees to opt out of auto enrolment, but paying funds into a pension may redirect money away from the cause they are engaged to work for, and it may be that individuals are more amenable to opting with this in mind. And how many charity workers can afford to find an alternative way to plan for their financial future when we are told the State Pension will simply not provide enough income?
Charities which are forced to trade, or even make investments, to replace lost income are obliged to put what money they make into the benevolent activity of the business. Yet the reality is that this work would not happen without the people employed by the charities. They are the people who make the core activity happen. Therefore charities are left with little choice. Either the share of their income which generally goes into the beneficiary cause is reduced, or they must raise additional income.
Hitting the streets or, more commonly these days the internet, and pushing for more money because the cash donations of last week have been swallowed up in the pensions of employees is a tough emotional "sell", with arguably no alternative. The pension changes are on their way and this means that the cost of manpower is rising for all employers, whether they run a construction giant or a hospice.
Charities unaware of what is coming
STEPHEN NICHOLS of THE PENSIONS TRUST comments: The introduction of auto-enrolment at the end of this year will mean employers will be forced, by law, to offer their employees a workplace pension scheme. While this year will see only those employers with over 30,000 employees needing to comply with auto-enrolment regulations, by the end of 2013 any employer with over 350 employees will need to offer a workplace scheme. As such, charity employers need to start preparing now if they haven't already begun.
There was a recent survey among over 700 voluntary sector organisations and social enterprises to find out more about their awareness of auto-enrolment and their knowledge of the responsibilities it will bring. The eye-opening results reveal that only 9% believe they have total awareness of the new auto-enrolment regulations, with one in seven employers (14%) having little or no awareness of its responsibilities.
Additionally, the research showed that the smaller the organisation, the more likely it will be to be in need of further guidance. While smaller organisations will have more time to prepare for auto-enrolment, this does not mean they should rest on their laurels and do nothing It is vital that all voluntary sector organisations, regardless of size, do what they can now to make sure they are properly prepared. After all, responsibility for complying with the regulations sits with employers themselves.
It's a tough time at the moment for voluntary sector organisations, and it's safe to say that many employers will be more concerned about the additional strain that auto-enrolment will have on their bottom line than the actual pension product. Charities must work with providers which can help them comply with auto-enrolment regulations, and minimise their pension costs. In addition, employers in the charity sector still offering open defined benefit (final salary) schemes will come under ever increasing pressure to convert to defined contribution (money purchase).
Getting ready for auto-enrolment is a big task for many charity employers, and the research has highlighted that many feel they need guidance through the process.
Charity employers will have staged deadlines
MICHAEL GARVEY of EDINBURGH WEALTH MANAGEMENT comments: New employer obligations under the NEST (National Employment Savings Trust) regime will be gradually "staged" in from 1 October 2012 (for organisations with more than 120,000 staff) until 1 September 2016 for smaller organisations. "Staging Dates" can be ascertained by charities from the Department for Work and Pensions website. In all instances, the Pension Regulator will inform all employers of their Staging Date 12 months before and again 3 months ahead as a reminder in order that they can prepare to automatically enrol all relevant jobholders.
Until their Staging Date is arrives, organisations remain bound by current Stakeholder legislation which only applies to firms with more than 4 employees. Under these rules – which will be completely superseded by NEST – employers must offer access for all staff to a stakeholder pension plan. This legislation has failed as employers are currently under no obligation to pay into the scheme on the employee's behalf, and so there is no financial incentive for staff to join a scheme which they could otherwise start privately if so inclined.
Hypothetically, if all eligible jobholders are automatically enrolled into a NEST compliant pension scheme and choose to remain so (i.e. do not opt out), then this will add a minimum of 3% of salaries on to payroll to cover employer contributions – an expense which charities will have to absorb. In practical terms, it is very unlikely that no staff at all will opt out for a variety of reasons (e.g. affordability) and so the actual cost to the charity will realistically be lower. However, charities should begin budgeting for this additional cost in advance once their Staging Date has been determined.
Most responsible charity employers will have some form of pension scheme in place for staff already if even simply a stakeholder scheme. These charities should undertake a due diligence exercise to determine whether the scheme that they have will be NEST-compliant and if not take steps to address any issues ahead of their Staging Date. For example, are employee and employer contributions sufficient to meet NEST criteria?
Additionally, idiosyncrasies of some schemes (for example, existing "salary sacrifice" arrangements) should be checked to confirm compliance. Employer and employee contributions will be quantified as a percentage of salary ignoring previous arrangements agreed between employer/ employee which will mean a lower contribution based as a consequence of the "post-sacrifice" salary being used as the basis for calculation.
Charity employers should also be mindful of the changes from the employee's perspective and how to communicate the changes to their workforce. In particular, staff may have investment decisions to make around how their retirement fund is invested. Also, staff should be aware that transferring funds into or out of the Government NEST scheme (if indeed this is the avenue that the employer opts for) will not be allowed initially. Higher earners should also be mindful that contributions into the Government scheme will initially be restricted to £300 per month or £3,600 per annum.
All charity employers will be affected
ANDREW RACKHAM of accountancy group SMITH & WILLIAMSON comments: The Pensions Commission presented its report on the UK's pensions crisis in 2005. It will be no surprise for those familiar with the complexity of pension provision that seven years later the report's main recommendation, automatic enrolment of employees into a workplace pension scheme, is only now to take effect. All employers will be affected by automatic enrolment. However, a recent ACEVO survey reported that whilst an increasing number of charities have an automatic enrolment strategy in place, 31% still need to make plans to ensure 'auto-enrolment' compliance.
Employers with fewer than 50 people in a PAYE scheme can delay auto-enrolment until 2015 whilst employers with between 50 and 250 employees can delay until 2014. Larger UK employers (those with 250 or more individuals on their payroll) can no longer ignore this issue, however, as their "Staging Date" arrives, at the earliest, this October.
All employers will need to understand the definition of "worker" (in essence, all employees including, potentially, agency staff) and "officeholder" (primarily non-executive directors and individuals without a contract or service agreement). Volunteers without a contract of service would not be classified as workers unless they receive any form of payment or non-financial benefit.
Analysis of the various categories of worker also needs to be undertaken. For those human resource professionals who relish the complexity of pension provision, this area will be a particular delight. Eligible jobholders (UK employees earning £7,475.00 per annum and aged between 22 and state pension age) are, as the name suggests, eligible for auto-enrolment.
Non-eligible jobholders, who can opt-in to auto-enrolment if they wish, are UK employees aged between 16 and 22, or between State Pension age and 75, with earnings over £7,475.00. Non-eligible jobholders can also be UK employees earning between £5,035.00 and £7,475.00 per annum and aged between 16 and 75.
Entitled workers (UK employees earning below £5,035.00 per annum and aged between 16 and 75) find themselves, unsurprisingly, entitled to join a pension scheme. Employees will move between categories as they age and accrue salary increases, creating administrative headaches for employers trying to identify relevant individuals.
ANDREW RACKHAM of SMITH & WILLIAMSON continues: The majority of UK employers affected from October 2012 onwards are likely to have some form of pension provision in place already. For these employers, a key question to ask themselves is whether their existing arrangements will fulfil their auto-enrolment duties. If not, the arrangement must be modified or consideration given to the provision of a new arrangement, perhaps by using the Government sponsored National Employment Savings Trust (NEST).
Minimum qualifying standards for defined contribution arrangements and personal pensions require the employer to make minimum contributions of 1% of the jobholder's qualifying earnings (currently between £5,035.00 and £33,540.00 per annum) rising to a minimum of 3% by 2018. For active members of the few defined benefit schemes still around, minimum qualifying standards are broadly equivalent to the requirements for contracting out of the State Second Pension. For non-contracted out arrangements, providing the scheme offers benefits at least as good as a hypothetical scheme (the so called 'test scheme standard') the arrangement will also be qualifying.
With regular coverage in the media of declining pension provision and the closure of many occupational pension schemes, it is hardly controversial to suggest that employers and the pensions industry are challenged in persuading individuals that pension provision is worthwhile. It therefore seems a retrograde step that one feature of auto-enrolment is the ability for eligible jobholders to "opt out" of the auto-enrolment provision, if they so wish, within one month of enrolment.
ANDREW RACKHAM of SMITH & WILLIAMSON says: Even when an employee decides to opt out, the employer will still be required to automatically re-enrol 'opted-out' employees every three years. A recent National Association of Pension Funds report suggested that a third of employees plan to opt out with the majority of these respondents stating that the affordability was the key deciding factor.
The age old adage "charity begins at home" pre-dates even the UK's pensions crisis. Employers in the charitable sector who have an interest in the retirement provision of their employees will have similar altruistic views but should be mindful that it is the employer who will bear the cost, grapple with the complexity and suffer the potential confusion arising from auto-enrolment compliance.