To help simplify the pensions system and decisions about retirement savings, the Government has decided to abolish contracting out on a defined contribution basis.
At the moment, some pension schemes are set up to provide a pension which replaces all, or part, of the additional State pension (also called the State Second Pension). This includes some company, stakeholder and personal pension schemes. When you join one of these pension schemes, you are said to be ‘contracted out’ of the additional State pension.
There are two ways of contracting out, based on how the benefits are to be calculated. Some company schemes, generally money purchase or defined contribution schemes, along with personal and stakeholder pensions, contract out on a defined contribution basis. Other company schemes, normally defined benefits schemes, are contracted out on a salary- related basis. Currently individuals who are members of a contracted out scheme pay lower National Insurance contributions and/or receive some National Insurance rebates into their pension scheme.
The Government are planning to end contracting out of the additional State pension on a defined contribution basis from 6th April 2012. The planned changes mean that you will no longer be able to use a pension contracted out on a defined contribution (money purchase) basis in place of the additional State pension. Instead you will automatically be brought back into the additional State pension and, depending on your earnings; you may begin to build up entitlement to the additional State pension from this time. In most cases you will earn entitlement to the additional State pension.
There may be some cases in which you won’t, for example if you stop working or earn less than the Lower Earnings Limit.
The National Insurance rebates an individual and, where applicable, their employer currently get if they are contracted out are intended, when invested in the contracted- out scheme, to provide benefits broadly the same as those given up in the additional State pension. However, benefits from defined contribution schemes can vary depending on investment returns and annuity rates. This means it is difficult for individuals to predict with any degree of certainty whether they would be better off in the additional State pension or contracted out. To help simplify the pensions system and decisions about retirement savings, the Government has, therefore, decided to abolish contracting out on a defined contribution basis.
From 6th April 2012, instead of receiving rebates of your National Insurance contributions you may begin to build up entitlement to the additional State pension. For every year that you pay National Insurance on earnings over £5,044 a year (based on 2010/11 earnings) you will get around an extra £1.60 a week on your State pension when you come to claim it. People earning above £14,000 per annum (based on 2010/11 earnings) will also be entitled to an extra earnings- related payment but the earnings- related payment will be gradually withdrawn so that by 2030, additional State pension will be made up of the flat- rate amount only.
If you require any further information on the ‘Abolition of contracting out on a defined contribution basis’ please do not hesitate to contact our office on 01634 281145.
