Contracting-out of the State Second Pension on a money purchase basis (known as a ‘protected rights’ basis) will be abolished from 6 April 2012.

This change affects trust-based money purchase schemes, defined benefit schemes that contract-out on a protected rights basis and personal pension schemes (including group personal pension schemes).

What will happen following the abolition of protected rights?

No active member will be able to build up protected rights from 6 April 2012. Members who are currently contracted-out on a protected rights basis will be contracted-back into the State Second Pension on that date. Employers and employees will no longer be able to pay reduced rate national insurance contributions (NICs) and will be required to pay standard rate NICs instead. Affected schemes will no longer receive contracted-out rebates, although payments relating to the 2011/12 tax year will still be paid, even if payment is credited after 6 April 2012.  

However, the good news is that all the current restrictions that apply to protected rights will fall away. So all money purchase benefits from a scheme on the death or retirement of a member will be treated in exactly the same way. This will simplify scheme administration, as there will be no need to separately identify benefits that were previously known as ‘protected rights’.  

Employers who currently have members who are contracted-out on a protected rights basis could, in theory, decide to switch them to contracting-out on a defined benefit basis. This will only be of relevance (if at all) to defined benefit schemes that are currently contracted-out on a protected rights basis.

Employers - what do you need to be doing?

If you are an employer who sponsors a contracted-out money purchase scheme or offers a group personal pension arrangement under which members may choose to contract-out:

  • consider the impact of increased NICS on both employees and participating employers from contracting-back in to the State Second Pension  
  • consider whether introducing a salary sacrifice arrangement to offset the increase in NICs would be viable (if you do not already offer such an arrangement)  
  • if you have a trust based scheme which provides a protected rights underpin, take advice on re-designing your benefit structure and discuss with the scheme trustees  
  • decide whether it is viable to continue to contract-out employees by switching to a defined benefit contracted-out basis from 6 April 2012 (unlikely to be popular)  
  • communicate with your employees in advance of the April 2012 changes.

Trustees - what should you be doing?

If you are a trustee board with a scheme which contracts out (in whole or in part) on a protected rights basis:

  • talk to the participating employers about what will happen from 6 April 2012  
  • update your scheme rules to remove any unnecessary restrictive conditions relating to protected rights. The Department of Work and Pensions (DWP) is currently consulting on draft regulations (the Occupational Pension Schemes (Contracting-out and Modification of Schemes) (Amendment) Regulations 2012) which, if passed, will introduce a statutory power allowing trustees to amend rules by resolution to give effect to the changes. Passing a resolution would avoid the need to comply with the usual amendment power formalities under the scheme rules.  
  • consider member communications and updating the member booklet  
  • liaise with your administrators on how they will manage matters from 6 April 2012. Useful Information  

The DWP and HMRC have issued some helpful factsheets for employers and trustees to assist with planning for the abolition of contracting-out from April 2012. Go to: http://www.dwp.gov.uk/docs/emp-contracting-out-factsheet.pdf and http://www.dwp.gov.uk/docs/trustee-contracting-out-factsheet.pdf

HMRC has now issued the fourth bulletin in its ‘Countdown’ series, updating administrators about the abolition of contracting-out. To view it go to: http://www.hmrc.gov.uk/nic/countdown-bulletin4.pdf.

Technical information

Section 15 and Schedule 4 to the Pensions Act 2007 abolish contracting-out on a defined contribution basis from 6 April 2012, by amending the relevant provisions of the Pensions Schemes Act 1993. Section 106 of the Pensions Act 2008 comes into force on 6 April 2012 and abolishes the restrictions that currently apply to protected rights. That section amends the relevant provisions of the Pension Schemes Act 1993 and Section 15(4) and Schedule 4 of the Pensions Act 2007.

See also the Pensions Act 2007 (Abolition of Contracting-out for Defined Contribution Pension Schemes) (Consequential Amendments) Regulations 2011 and the Pensions Act 2008 (Abolition of Protected Rights) (Consequential Amendments) Order 2011, the majority of both sets of regulations coming into force on 6 April 2012, (with part 3 on 6 April 2013 and part 4 on 6 April 2015) and the Pensions Act 2007 (Abolition of Contracting-out for Defined Contribution Pension Schemes) Consequential Amendments)(No 2) Regulations 2011, in force on 6 April 2012.