Contracting-out under defined contribution schemes ended on 6 April 2012. It will be the turn of defined benefit schemes on 6 April 2016.

The end goal sounds simple: a single-tier state pension.  The journey there may not be quite so simple!

What effect will the end of contracting-out have on your defined benefit scheme and its members?

  • The state second pension will be discontinued
  • Contracted-out schemes will cease to be contracted-out for future service
  • Reduced National Insurance contribution paid by members and employers will be replaced by the full level
  • Draft regulations propose that:
    • GMPs will still need to be provided in respect of service between 1978 and 1997; and
    • Rights attributable to post-1997 service will also be protected.

Increased National Insurance contributions – who pays?

The increase in employer costs stemming from the increase in the rate of National Insurance contributions is of concern to some employers. 

A solution would be to amend the rules of the scheme to help employers offset this additional cost.  However all such amendments would need to be made in accordance with the scheme's power of amendment.  Often this will require trustee consent.  Occasionally the power of amendment may be so restrictive that such amendments are prevented or restricted.

Help is at hand for employers though.  The DWP is currently consulting on draft regulations which it hopes to bring into force later this year.  Those regulations include an overriding power for employers to amend the rules of their pension schemes (without trustee consent) to enable them to recoup the cost of the increased level of employer National Insurance contributions.  Recovery of costs in this manner will be limited to the extra cost of National Insurance contributions resulting from this change.  That will be managed by the requirement that any such scheme amendments must be accompanied by certification from an actuary that the employer is not recouping any more than the cost resulting from the abolition of contracting-out.  The draft regulations set out a framework for actuaries to use when conducting these calculations.

Employers and Trustees will also need to consider whether any further amendments to their scheme rules will be required in respect of future accrual of benefits, particularly where they currently integrate the scheme's benefits with the state second pension.

Another thing to add to the to-do list for those responsible for managing final salary pension schemes!