Chancellor George Osborne’s recent announcement that the government wants to bring the living wage to £9 by 2020 will have had many charity finance directors scratching their heads, wondering where the extra income is going to come from.
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, this could present a material additional spend.
Impact on accrued benefits
It will be more worrying, however, for those charities that 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 with 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.
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
This would equate to a salary of £13,520 a year, which would increase to £18,720 by 2020, an increase of just over 38 per cent, or about 7 per cent a year.
As contributions are based on salary, the cost of future benefits will also effectively increase by 38 per cent.
More significant, however, is the impact on benefits already accrued, as these are also based on salary.
The impact in pension terms will depend on the number of years the individual has been building up benefits.
If we take someone in a final salary scheme with 20 years of service, accruing 1/60th a year, 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.
Material impact
This example represents just one individual and organisations need to multiply the impact up by the number of employees 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 recent years to suppress 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 DB schemes could be material, as funding valuations may well be assuming lower salary increases than may ultimately be the case.
Even employers participating in The Pensions Trust schemes, who have looked to limit the impact of DB accrual by moving to DC 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 is not just limited to pensions, as there could be increased costs associated with risk benefits such as death-in-service cover and permanent health insurance.
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 is an owner/director and head of public sector, charities and not-for-profit practice at Spence & Partners
