Personal PensionNov 19 2015

Is AE a cost or a profit?

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Is AE a cost or a profit?

There are two types of employer, advisers tell me, when it comes to workplace pensions – those who see their pension as a ‘cost centre’ and those who see it as a ‘profit centre’.

“Which type is he?”, is the first question an adviser needs to answer when meeting a new employer client – whether it is a small employer seeking support with auto-enrolment for the first time or a large employer asking for consultancy for their established scheme.

Employers who see their pension as a cost do not really want to have one. The only benefit is compliance – so as long as it is compliant they will want to minimise its cost.

This means paying the lowest contributions possible to their people. For example, choosing band earnings as the definition of pensionable pay – so a minimum of £5,824 is knocked off the calculation and a lower minimum percentage applies too.

They would avoid advice if they could – and certainly pay as little for it as possible. They would prefer no provider cost above that paid for by the members.

All this may make cost-centre employers sound terrible – I am certainly not saying that. They simply prioritise other things. Perhaps their employees do not particularly want a pension and would prefer a bonus payment instead. Or maybe there is a surplus of skilled people in their field and it would not make economic sense to target a higher-value benefits package.

The other type of employer views their people as one of their most valuable assets. If they are going to have a pension – and wider benefits package – they will want it to give them a competitive edge in relation to ‘the four Rs’, by helping them:

- recruit the best people;

- reward their people for strong performance;

- retain the best people for longer; and

- retire their people, so they are not continuing to work just because they can not afford to stop.

These employers see their pension contributions as an investment in their business. By paying a bit more than the minimum they should stand out from the crowd.

They will want the quality of their pension to be consistent with this and be more prepared to pay a little towards it – in their form of advice or fees to a provider they believe in.

The administration burden will still be a genuine cost – not an investment. Minimising the administration requirement and hassle will leave more time and resources to be spent on the core business.

It is natural to expect smaller employers to be more likely to be in the ‘cost-centre’ camp. But this is not just a factor of size. A few of the largest employers seem to view their pension as a cost to their business, while many SMEs will be looking for an edge in a competitive employment market.

Indeed, small employers will know every person in their business. Many will feel a responsibility to “get it right” for their friends, business colleagues and, often, family members.

Employers who turn to an adviser or consultancy firm may more usually be in the ‘profit-centre’ camp. Otherwise, why not just go online and pick the cheapest option?

A quality pension can mean lower admin costs for sure, so some of the ‘extra cost’ associated with some advice or pension provider solutions may be recouped through lower ongoing resource drag.

The main benefit to employers with a ‘profit-centre’ outlook will be more prosperous futures for their people – and the differences can be huge.

Consider twins called Jack and Joe. Both have exactly the same salaries (starting at £26,000) and identical attitudes to saving. Jack works for a ‘cost-centre’ employer who puts in place a fully compliant, low-cost workplace pension. Joe works for a competitor in the same industry, who takes a ‘profit-centre’ approach and selects a higher quality/higher ‘investment’ solution.

Jack is enrolled in his pension at the mandatory minimum, saving £34 each month including his employer’s contribution. Joe’s employer uses basic pay for pension calculations. Even though Joe starts at the statutory minimum percentages, this results in £65 each month going in – nearly double than for Jack.

Jack receives a statement once a year that ends up in his shoebox filing system.

Joe, on the other hand, feels much more supported. He likes to check out his pension on his mobile app every few months to see his employer contributions and tax top-up going in. He knows where to go for information, and finds the experience very slick and helpful. He increases his contribution after a year or so to 5 per cent of his salary, benefiting from employer matching. This increases his monthly savings to £217. A while later he consolidates a small pot he has somewhere else, which helps him keep an eye on it all in one place.

All this means that when statutory minimum contributions increase, they do not affect Joe as he is already saving more. Jack on the other hand is not feeling engaged in his pension and just sees his take-home pay being hit.

When markets crash, Joe is kept informed and can take a long-term view. Jack is much more likely to opt out or make a poor investment choice.

The paper ‘Outcomes and Defined Ambition’ found that a 1 per cent extra return each year for the same level of risk is equivalent to a 23 per cent increase in retirement savings. So Joe could benefit substantially more than Jack if his money is invested more effectively. Also, reducing the volatility of the investment means Joe is less likely to panic than Jack, who will see much more severe variations in his savings from month to month.

Jack receives the statutory minimum retirement information, meaning he gets it six weeks before he plans to retire. This is way too late to take action and he is devastated to learn how little income his pension can buy. He paid the minimums specified by the government, so he cannot understand why that was not enough.

Joe has been keep informed throughout, with his support ramping up from the age of 50. So after a prompt he increased his contributions again, selected an appropriate investment choice for how he planned to take his money and even paid his £10,000 Isa money into his pension at age 55 – for a better tax environment and retaining immediate access.

Even without allowing for an investment growth difference, Joe retires with more than twice as much in his pot. The difference means a lot. With state pension included, Jack’s resulting income of about £200 per week may well be lower than required for a ‘minimum acceptable standard of living’ (for example see https://www.jrf.org.uk/report/minimum-income-standard-uk-2014). Joe’s result is much better. He can retire when he wants to and look forward to his older age with confidence.

Alan Ritchie is head of employer and trustee proposition of Standard Life

Key points

Some employers see workplace pensions as a cost centre and others as a profit centre.

The administration burden of auto-enrolment is a genuine cost.

A 1 per cent extra return each year for the same level of risk is equivalent to a 23 per cent increase in retirement savings