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The end of contracting out

The new State Pension to be introduced from 6 April 2016 will replace both the old Basic State Pension and the Additional State Pension (known as the State Earnings Related Pension Scheme up to April 1997 and the State Second Pension afterwards).

Previously many employers elected that their occupational pension schemes be contracted out of the Additional State Pension. In doing so, both the member and the employer paid a reduced rate of National Insurance (NI) contributions, in return for providing the equivalent to the Additional State Pension as part of their occupational scheme pension benefits.

From April 2016, this facility for defined benefit schemes will no longer be possible (defined contribution arrangements ceased the facility in 2012) so that all schemes will become contracted in, and therefore, both the employer and the employee will have to pay a higher rate of NI contributions although at the same time accruing a higher level of State pension.

There are a number of important factors that both the employer and the trustees of occupational schemes should consider ahead of April 2016, as if they have not done so, time is ticking.

Firstly, they should analyse the impact of the increased NI contributions payable on payroll. The current rebate is 3.4% of the earnings between the Lower Earnings Limit (£112 per week) and Upper Accrual Point (£770 per week) for the employer and 1.4% of earnings between the Lower Earnings Limit and Upper Accrual Point for the member.

Having established this, the employer then needs to consider what action can be taken i.e. if this impact can simply be absorbed by the members and/or the employer, or if, as a consequence, they wish to mitigate their costs in some way. This could include altering the future benefit structure (e.g. reducing the members’ accrual rate, or asking the members to make an increased rate of employee contributions to the scheme in order to remain at the current level of accrual).

Pension regulations that come into force from April 2016 will allow the principal employer the statutory amendment power to make either of the changes used as examples above without the need for consent from either the trustees or scheme members. However, it is important to note that any savings achieved from the changes must not exceed the employer’s increase in NI liabilities. If the employer wants to make more extensive changes, another legal mechanism (such as the scheme’s own amendment power) will need to be used instead, which would likely require consent from the trustees. Employers should also be aware that some schemes, such as those previously owned by the public sector, may have protected benefits that cannot be altered by the statutory override. Legal advice will therefore be required in this matter.

If an employer proposes changes to the scheme, whilst consent is not required, the usual 60 day consultation period still applies, and therefore any proposed actions to take effect from April 2016 will need to take place no later than the end of January. As ever, the employer should ask the trustees to review the consultation documentation before it is released to ensure that they remain onside.

The employer could obviously choose simply to absorb the impact of their (and their members’) increased NI labilities. In fact, the option to reduce the employer rate of contributions to the scheme to offset the increased NI contributions is not available, and HMRC has confirmed that this was intentional. If the employer does absorb the full impact, this could be a long term decision, or one simply taken until the next triennial actuarial valuation is carried out, as at that point, scheme funding will be discussed in more detail by the trustees.

If the employer does not agree to absorbing the costs of the increased NI liabilities in its entirety and therefore expects the members to “suffer” an increase in their own NI liabilities, then a communications exercise should be undertaken with all active members.

This exercise should explain the changes to the new State Pension, the abolition of contracting out, and the increased NI liabilities. Examples of members’ increased NI labilities should be provided, and it may also help to provide sample payslips, showing the impact on members’ take-home pay as a result of the changes. Your pension provider should be able to help with this matter. The Department for Work and Pensions has also produced a number of leaflets explaining the impact and it is useful to refer members to these.

There is a further consideration for the trustees. Prior to April 1997, the equivalent pension benefit that they must provide in their scheme as a result of contracting out is the Guaranteed Minimum Pension (GMP). As the scheme will no longer be contracted out, all schemes must reconcile the GMPs payable to their scheme members with HMRC. Currently the deadline for schemes to reconcile their GMP with HMRC is the end of 2018. This is done via the Scheme Reconciliation Service (SRS) which HMRC have setup specifically for this task. Trustees should register with SRS by 6 April 2016 otherwise they will not be allowed to access this facility.

If you have not considered this matter at all, or are only part way through the exercise you should contact your pension provider immediately. Quantum is happy assist in any way possible to ensure that you complete this task ahead of the deadline.


Martin Strevens