Living wage unintended consequences for charities

David Davison

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The article below appeared in Pensions Expert on 23 November 2015, in the Informed Comment section of the publication.

The Chancellor George Osborne’s recent announcement that the Government’s objective to see the living wage increase to £9.00 by 2020 will have had many charity finance directors scratching their heads and wondering where the extra income is going to come from to fund this.

I suspect however that many will not as yet have got around to considering the pensions impact of the change, which for some will be very significant.

For those with defined contribution schemes, likely to be the majority, the increase will just be an additional annual contribution cost for those affected.  However, given that we will be well into auto-enrolment implementation at maximum employer contribution rates as we move to this objective this could present a material additional spend.

More worrying, however, would be those charities who participate in defined benefit arrangements, either their own or multi-employer arrangements such as local government schemes or industry wide schemes. In this case, employers will not only have to deal with the future contribution impact but also additional costs as a result of associated increases in benefits.

As an example, let’s look at someone over the age of 21, who is currently earning the £6.50 minimum wage and working 40 hours a week throughout the year.  This would equate to a salary of £13,520 per annum which would increase to £18,720 by 2020, which is an increase of just over 38% or about 7% per annum. Clearly as contributions are based on salary the cost of future benefits will also effectively increase by 38%.

More significantly, however, is the impact on benefits already accrued as clearly these are also based on salary. The impact in pension terms will depend on the number of years the individual has been building benefits. So if we take someone in a 60th final salary scheme with 20 years service, it would equate to an increase in accrued pension of £1,733. For someone with 30 years, it would be £2,600. That would equate to a liability increase just on the past benefits of between £60,000 and £85,000 which will need to be funded in addition to the cost of future benefits. There will of course be some assumption for future increases in pensionable salary but they are likely to be in the region of 1%-2.5% per annum, considerably below the 7% per annum outlined above, which is clearly likely to result in an increased spend.

Clearly this example represents just one individual and organisations need to multiply the impact up by the numbers of staff who will be affected. It is entirely possible that the overall additional liabilities across charities’ DB schemes could run into hundreds of millions of pounds and additional annual costs of many millions.

The issue will also impact those earning above minimum wage as many charities have been forced over the last number of years to suppress staff salary increases. There will therefore come a point where the minimum wage or new living wage will start to bite.

The impact of this on defined benefit schemes could be material as funding valuations may well be assuming lower salary increases than may ultimately be the case in reality.  Also, increasing deficits will lead to changes in future assumptions which will also increase liabilities both from a funding and accounting perspective.

Even employers, such as those who participate in Pension Trust schemes, who have looked to limit the impact of defined benefit accrual by moving to defined contribution, could still be adversely affected, as within these schemes closure to future DB accrual does not remove the link to salary for current employees on the DB benefits already built up.

And the impact isn’t just limited to pensions as there could also be increased costs associated with risk benefits such as death-in-service cover and PHI.

When setting future budgets charity Finance Directors need to be aware of the likely impact these changes could have on their future finances and begin to prepare for it.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

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