The removal, from April 2016, of contracted-out status for defined benefit scheme.

September 23, 2014
Baxter & Co
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One of the less well publicised provisions of the Pensions Act 2014 was the removal from April 2016 of contracted-out status for defined benefit scheme. This is part of the changes for the introduction of a single-tier state pension from that date.

From April 2016 contracted out schemes will need to pay the standard rate of national insurance contributions, this represents a 3.4% increase in national insurance cost on relevant earnings (earnings between £5,772 and £40,040 for the current year) for each contracted out employee. For large schemes this will be a significant additional cost.

As the minimum standards for being a contracted-out scheme will no longer apply when contracting-out ends, the scheme rules can be changed to help offset the additional costs, either by reducing future pension benefits or by increasing employee contribution rates. Usually, this would require the trustees consent, but the government has been consulting on draft regulations to allow employers to make certain changes to scheme rules, without such consent.

From April 2016, employees will cease to receive the national insurance rebate and also start to pay full rate national insurance contributions. This will mean an increase in their contributions equivalent to 1.4% of relevant earnings. At the same time employees may face a reduction in the value of their scheme benefits or an increase in their pension contribution rates, if their employer seeks to recoup the additional employer national insurance costs by amending their scheme rules as outlined above.

This is a significant additional cost and employers will have to decide how the burden is to be split between themselves and the employees. The government estimates that even taking account of the additional contributions and loss of benefits, 85% of employees retiring within two decades of 2016 will be no worse off than at present. Clearly though a proportion will be and employers need to start planning how they will deal with these changes. To help in this process we have developed an easy to use calculator to estimate the potential increase in national insurance cost. This is available from our payroll department:

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