CONTRACTING
OUT IN MONEY PURCHASE, PERSONAL AND STAKEHOLDER PENSION
ARRANGEMENTS IS NOT POSSIBLE FROM 6 APRIL 2012.
By contracting out, instead of building
up entitlement to the Additional Pension (previously known
as the State
Earnings Related Pension Scheme (SERPS) and now known
as the State Second Pension (S2P)),
an individual will instead transfer that pension liability to a
private arrangement.
Scheme Types
Since 6 April 1978, it has been possible for final
salary and career
average schemes to contract out of SERPS.
From 6 April 1988, the ability to contract out was also made
available to members of money purchase schemes, personal pension plans and
stakeholder pension schemes,
but this stopped fom 6 April 2012
Final Salary and Career Average Schemes
IT IS STILL POSSIBLE TO CONTRACT OUT
IN FINAL SALARY AND CAREER AVERAGE SCHEMES
Where an individual joins a final salary or career average
scheme, the decision whether to contract out or not is made by the
scheme. If the scheme is contracted out, by joining the scheme an
individual will also to be automatically contracted out and both
the employee and the employer will pay National Insurance
Contributions at a reduced, contracted out rate.
Before 6 April 1997 a contracted out final salary or career
average scheme was obliged to provide a minimum benefit known
as Guaranteed Minimum Pension
(GMP) which replaces an individual's SERPS entitlement. From 6
April 1997, a scheme no longer had to provide GMP benefits in
respect of service from that date. Instead the scheme will need to
demonstrate that benefits satisfy a test of quality which means
that they should be broadly equivalent to, or better than a series
of test benefits known as a notional reference scheme.
Money Purchase Schemes
CONTRACTING OUT IN MONEY PURCHASE,
PERSONAL AND STAKEHOLDER PENSION ARRANGEMENTS IS NOT POSSIBLE FROM
6 APRIL 2012.
Under a contracted out money purchase scheme, a contracted out
fund was established, made up of contributions equal to the amount
of both the employer's and employee's reduction in National Insurance
Contributions. This fund is kept separate from other
contributions and is known as Protected Rights.
Personal & Stakeholder Pension Schemes
CONTRACTING OUT IN MONEY PURCHASE,
PERSONAL AND STAKEHOLDER PENSION ARRANGEMENTS IS NOT POSSIBLE FROM
6 APRIL 2012.
Under a personal pension plan or stakeholder pension scheme,
the decision whether to contract out or not rested with the
individual. If an individual elected to contract out, they
continued to pay National Insurance
Contributions at the full rate but the government made a
contribution to their pension plan. The contribution consisted of a
rebate of part of both the employer's and employee's National
Insurance Contributions that had been paid, plus income tax relief
on the individual's share of the rebate.
This contribution was invested separately from any additional
contribution the individual made and the fund subsequently
built up is described as Protected Rights. There is no
guarantee that the pension eventually purchased by the Protected
Rights fund will be greater than the state additional pension given
up as a result of being contracted out. You will be allowed to take
25% of your Protected Rights fund as a cash sum, which will be tax
free.
Basic State Pension
Being contracted out will not affect an individual's right to
the basic
state pension.
Q & A's
From 6 April 2012 it is only possible to contract out in a final
salary or career average scheme. And only then if that scheme
gives you the opportunity.
This will depend on the type of pension scheme you are a member
of.
Each year you will build up entitlement to the Additional State
Pension based upon your earnings. Between 6 April 1978 and 5 April
2002 the additional state pension was called the State Earnings
Related Pension Scheme (SERPS). On 6 April 2002 the basis used to
calculate the Additional State Pension was amended to make it more
generous for low and moderate earners. It is now known as the State
Second Pension. Like the basic state pension, the Additional State
Pension is payable from state pension age.
If your employer runs a final salary or career
average scheme, they will have made the decision whether the
scheme should be contracted in or out. If the pension scheme is
contracted out, the decision has effectively been made for you and
you cannot contract in to the State Second Pension. However, the
scheme will need to provide benefits that meet a test of quality
and as a result of joining the scheme, you will pay NI
contributions at a reduced contracted out rate.
The answer is difficult to predict and depends on a number of
factors. Primarily these are:
- How much rebate and tax relief is paid to your plan;
- The investment performance of your plan. You should bear in
mind that there is no guarantee that investments will always have a
positive return;
- The annuity rates when you purchase an annuity. The available
annuity rates are what determines the conversion of your fund into
an income for the rest of your life.
- The charges made by your plan provider.
When contracting out you decided to forego the benefit of a
defined benefit scheme (the State Second Pension) in return for the
uncertain but potentially higher pension from a money purchase
personal plan. The resulting pension could also be lower than what
you would have got had you stayed in the State Second Pension.
If you have concerns that the advantages, disadvantages and
risks of contracting out were not properly explained or that you
were given mis-leading information, you should write to the company
that recommended contracting out and ask them to review their
advice. If they agree that their advice was inappropriate they
should take steps to compensate you. If you remain unhappy with
their decision, you will then have the right to ask the Financial
Ombudsman Service to adjudicate.
No, the State Second Pension does not provide a cash sum. The
benefits are paid as a pension until you die.
