UK - The government may use an annual reconciliation mechanism as the solution to the potential benefit gap between personal accounts and employer sponsored schemes caused by the current definition of the "qualifying earnings" limit.

In a statement to the House of Lords debate on the Pensions Bill, the government representative, Lord McKenzie of Luton, recognised the concerns a number of stakeholders have raised about the practicalities of introducing a qualifying earnings limited related to banded earnings.

Four industry bodies - including the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF) - issued a joint briefing paper before the debate began in June, which claimed members of defined contribution (DC) schemes could see their benefits cut by up to £5,000 a year. (See earlier IPE article: Lords warned of 'qualifying earnings' risk)

This is because existing occupational pension schemes tend to base pension contributions on an individual's basic pay, while the government is proposing contributions to personal accounts should be a minimum of 8% of banded earnings - between £5,035 (€6,338) and £33,540.

However, this means for employers to receive exemption from the personal accounts legislation, any existing 'good' pension scheme will have to measure contributions in the same way, so schemes would either have to change their rules, or there would need to be some kind comparison test to ensure scheme's are meeting the requirements as pay could differ on a monthly basis, for example through bonuses or overtime.

As a result, Lord McKenzie confirmed in a recent meeting of the House of Lords he and Mike O'Brien, minister for pensions reform, have been in discussions with stakeholders - including the ABI and NAPF - "about how we can make the test as simple as possible while still preserving the new minimum level of pensions savings". 

He said: "We focused on a suggestion by a group of four stakeholders—the ABI, NAPF, ICAEW and SPC—the essence of which is annual reconciliation, which we have also been thinking about for a while.

"A key objective for the government is to avoid disruption for existing schemes so that good arrangements may continue to function beyond 2012 without unnecessary changes or additional administrative processes. More detailed discussions with key stakeholders are already planned, and I fully expect to be able to be clear about our approach on Report [the final stage of debate]," he added.

However, John Lawson, head of pensions policy at life insurer Standard Life, claimed the idea of an annual reconciliation mechanism would mean employers and employees would have to make up any shortfall in contributions at the end of the year.

He claimed this would affect workers who wait for their annual bonuses before leaving a company, and those who take on a lot of overtime during the year, as the increase in their pay would mean they get caught under the qualifying earnings band and may have to pay an unexpected pension contribution. 

In addition, Lawson pointed out that "trying to get money from low earners at the end of the year will be quite difficult", and as a result it could drive a number of these target members to leave the pension scheme.

He said the reconciliation method would be essentially "comparing like-to-like" - what the contributions should be under the banded earnings definition and what the contributions are - so he warned there could be a large number of employers who have to pay a lot of contributions a the year end.

"This is not going to be as straightforward as the department for work and pensions (DWP) thinks. It will cause an enormous administration headache, plus it's going to cause behavioural effects - with people who can't afford to pay the shortfall coming out of the scheme", added Lawson.

Meanwhile, the continuing debate in the House of Lords also revealed the Personal Accounts Delivery Authority (PADA) has provided the government with "detailed advice on the cost and operational complexity of introducing a lifetime lump-sum facility" alongside an annual contribution cap of £3,600 - uprated from 2005 figures.

In response to concerns that low earning members may want to make up missed contribution years, invest an inheritance or to consolidate a number of 'stranded' pension pots into personal accounts, the government admitted it was looking at the issues "seriously".

In the original pensions white paper, the government suggested there could be a possible £10,000 one-off contribution cap to allow flexibility into the system, but details are still vague even though the current Pensions Bill provides the government with the power to adopt a lump sum facility.

Lord McKenzie said: "We are considering [PADA's] advice carefully and will make our decision in due course."

In the meantime, he also admitted "making an exception for stranded pots is a further area that we want to consider in some detail before we introduce the transfer-out regulations", and confirmed PADA and DWP are currently working together to develop "the likely content and approach" of further legislation and scheme rules for public consultation in March 2009.

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email