Contractedout. Part of the Department for Work and Pensions. Your guide

Transcription

1 Contractedout pensions Part of the Department for Work and Pensions Your guide October 2005

2 Why do I need a pension?

3 Contracted-out pensions Your guide Everyone needs to plan ahead for retirement. People are living longer and healthier lives, so it is even more important to think about how and when to save for retirement and how long to work. The basic State Pension will give you a start, but to have the lifestyle you want in retirement you need to think about a second pension. And the sooner you can start the better. This guide tells you more about leaving (contracting out of) the State Second Pension, raises some of the questions you need to think about and tells you where you can find more information. However, if you are selfemployed, you are not covered by the State Second Pension, which means that you do not have the option of contracting out. Other guides in this series will give you more information about particular areas of pensions. See page 31 for details about how you can get copies of these guides. 1

4 2 These guides can give you helpful information, but only you can make decisions about your pension.

5 State Pension There are two parts to the State Pension. Basic State Pension. You can build up entitlement to the basic State Pension if you pay, are treated as having paid or are credited with National Insurance contributions, whether or not you have another pension. Credited means that the Government has added some extra contributions to your National Insurance record for you. Additional State Pension. If you are an employee, you may be able to build up an additional State Pension on top of the basic State Pension. Up to April 2002, the additional State Pension was called the State Earnings-Related Pension Scheme (SERPS). SERPS was based on your record of National Insurance contributions and your level of earnings as an employee. You cannot build up entitlement to the additional State Pension if you are self-employed. From 6 April 2002, the Government reformed SERPS, creating the State Second Pension to provide a more generous additional State Pension for low and moderate earners, and for certain carers and people with long-term 3

6 illnesses or disabilities. (Any SERPS entitlement you have already built up will be protected if you have already retired or have not yet reached State Pension age.) The amount of additional State Pension you get depends on how much you earn while you are working for an employer. In general up to a certain limit the more you earn over your working life, the more State Second Pension you get. You can contract out of (leave) the State Second Pension by joining a contracted-out occupational, personal or stakeholder pension. If you join an occupational pension scheme that is contracted out, both you and your employer will pay a lower rate of National Insurance contributions to compensate for any additional State Pension you have given up. With some schemes (known as contracted-out money-purchase schemes), the Government will also pay an additional top-up rebate direct to the scheme to invest on your behalf. If you join a stakeholder or personal pension that is contracted out, both you and your employer will pay National Insurance contributions at the full rate (not the 4

7 contracted-out rate). HM Revenue and Customs will pay a rebate of contributions, together with tax relief on your share of the rebate, direct to your pension scheme. These payments are known as minimum contributions. If you would like to know more about them and how they are paid, please see the leaflet Employee s Guide to Minimum Contributions (CA17). See page 28 for details about how you can get a copy of this leaflet. Also, with this type of pension, you can contract out of (leave) the State Second Pension for a year at a time. So it is important that you regularly review your decision to contract out. Even if you contract out of the State Second Pension, you may still be able to build up some rights to it. For the tax year 2005/06, a member of a contracted-out occupational scheme earning between 4,264 and 27,800 will get a State Second Pension top-up. A person contributing to a contracted-out personal or stakeholder pension earning between 4,264 and 12,100 in the tax year 2005/06 will also get a State Second Pension top-up for that year. The top-up reflects the more generous State Second Pension for low and moderate earners. 5

8 6 It is also important to remember that whatever type of contracted-out scheme you join, we will reduce or remove completely your entitlement to the additional State Pension for any period that you are contracted out.

9 What happens if I decide to leave the additional State Pension by contracting out? 7

10 8 What if I leave the additional State Pension for an occupational scheme? Many people belong to an occupational pension scheme, but some occupational schemes are contracted in. If you join one of these schemes, your occupational pension will be paid on top of the additional State Pension. What types of contracted-out occupational schemes do employers run? At the moment, the following types of schemes are available: contracted-out salary-related schemes; contracted-out money-purchase schemes; and contracted-out mixed-benefit schemes, also known as hybrid schemes. Employers offering contracted-out pension schemes are responsible for making sure that their scheme meets the contracting-out conditions. They must tell their employees that their scheme is contracted out of the additional State Pension. HM Revenue and Customs is responsible for sending out contracting-out certificates. They will issue a certificate only once an employer has declared, in writing, that the scheme meets the contracting-out conditions.

11 Contracted-out salary-related schemes If you are a member of a contracted-out salary-related scheme (also known as a defined-benefit scheme), the pension you get will be based on: your salary when you leave the scheme (or, in some schemes, your average salary over the time you are a member of the scheme); and your length of pensionable service. Generally, both you and your employer will pay contributions into this type of scheme. From 6 April 1997, for a salary-related scheme to be able to contract its members out of the additional State Pension, it must meet a test of overall quality known as the reference scheme test. This test is aimed at making sure that contracted-out pension schemes meet the legal standard laid down in the Pension Schemes Act To meet this standard, schemes must provide benefits that are broadly the same as, or better than, those set out in the reference scheme test. This test sets a particular standard (benchmark) for members benefits and for widows and widowers benefits. 9

12 10 Contracted-out money-purchase schemes If you are a member of a contracted-out money-purchase scheme (also known as a defined-contribution scheme), your employer must make a minimum payment to your pension as a condition of the scheme being allowed to contract out. The minimum payment is an amount equal to the total of your National Insurance contribution rebate and that of your employer, and must be paid direct to the scheme trustees within 14 days of the end of the income tax month it relates to. HM Revenue and Customs will also pay an extra age-related rebate based on a percentage of your earnings between the lower and upper earnings limits ( 4,264 and 31,760 in 2005/06). This rebate is paid once a year direct to your pension scheme when HM Revenue and Customs receives your employer s end-of-year tax returns. This payment is on top of the rebate you and your employer receive through paying lowerrate National Insurance contributions. The final pension you get from a contractedout money-purchase scheme will depend mainly on: the amount of money paid into the scheme; how well that money has been invested; and

13 how long you are expected to be retired. That is why most schemes need you and your employer to make extra contributions on top of the minimum payment to boost the value of your pension fund. However, with this type of scheme it is the scheme member who takes the risk of the investment performing poorly, but there is also a chance that the investment will perform well. You will get tax relief on your share of the extra contributions. See How does contributing to a pension affect my tax payments? on page 21 for more details on tax relief. Contracted-out mixed-benefit schemes From April 1997, employers have been able to set up contracted-out mixed-benefit schemes. An example of this type of scheme is where the employer runs a contracted-out salary-related section and a contracted-out money-purchase section under the same scheme. If your employer runs this type of scheme and you decide to join it, the pension you receive when you retire will depend on which section of the scheme you belong to. Your employer must tell you which section of the scheme you can join. However, if you are in any doubt, you should ask either your employer or the scheme administrators for more details. 11

14 12 How can I find out more about my employer s scheme? If you want more information about your employer s scheme, or if you have a complaint, talk to the person at your workplace who deals with your scheme. Ask your employer who this is. If this person cannot sort out the problem, or you are still not happy, you can ask the scheme trustees or managers to look into the matter. If you want advice about your own pension after you have spoken to the person at work who deals with your pension scheme, you may want to talk to a financial adviser at a bank, building society or life assurance company, or to an independent financial adviser. Remember, if you see an adviser, you may have to pay for their advice. Should I leave the additional State Pension by joining my employer s contracted-out pension scheme? That is a decision only you can make. But, for many people, occupational pension schemes are usually a very good way of providing for their retirement. It is also for you to decide

15 whether or not this type of pension is suitable for you. This will depend on a number of things, including your circumstances, your working patterns and the amount you earn. It is also important to remember that many employers who provide occupational pension schemes contribute more to them than their employees do, and some run schemes where you don t have to pay any money at all. Employers must also give you details about any pension scheme they run and let you know if and when you are able to join it. For example, you cannot join some occupational schemes until you have worked for your employer for a set period. And, while many people who join an occupational pension scheme will be better off when they retire as a result of having joined the scheme, it is important to weigh up all your options before you make a decision. What if I want to leave the additional State Pension for a personal pension or a stakeholder pension? With a personal pension or a stakeholder pension, the National Insurance contributions rebate you get to compensate for the 13

16 additional State Pension you give up is invested on your behalf and used to provide benefits when you retire. So, you need to consider some very important issues before you decide to contract out with this type of pension. Here are some examples. When you retire, your contracted-out pension may provide a pension income of more than what you would have received from the state scheme if you had stayed contracted in. However, it may provide less. You need to consider whether you want to take this risk. Contracted-out personal pensions and stakeholder pensions offer a level of flexibility that is not available in the state scheme. For example, from April 2006 people will be able to use their contractedout pension fund from the age of 50 (rising to 55 by 2010) and take up to 25% of the fund as a tax-free lump sum. For some people, flexibility outweighs the risk of ending up with lower benefits. The amount you get will depend on how well the rebate money is invested and other things such as your age and marital status (married, single, divorced, widowed or separated) when you retire. 14

17 Unless you have a good understanding of all of these issues, you should get independent advice. Things you need to be aware of when you are contracted out Only you can make the decision to contract out, either by joining your employer s company pension scheme or by taking out a personal pension or a stakeholder pension. But if, after having weighed up all the issues, you do decide to contract out, you need to be aware of the following. You will still be entitled to any additional State Pension built up before you contracted out. You will lose some or all of your entitlement to the additional State Pension for any period that you are contracted out. You can boost the value of your pension fund by making regular contributions of your own. You will get tax relief on these extra payments. See page 21. At the end of each tax year that you are contracted out into a personal pension or stakeholder pension: 15

18 HM Revenue and Customs will pay a rebate direct to your pension scheme together with tax relief, at the basic rate, on your share of the rebate; if you later become self-employed or give up work but can still afford to save for your retirement, you can continue to make payments into your pension (you will no longer be entitled to a rebate but tax relief will continue); and contracting out is not a one-off decision. If you want, you can contract back in at any time in the future. However, you will only be able to do this from either the beginning of the tax year in which you make that decision or the beginning of the following tax year. 16

19 What else do I need to think about? 17

20 What happens if a contracted-out salary-related scheme has to wind up? Winding up is the process of ending an occupational pension scheme. This may happen for a number of reasons depending on a scheme s rules. For example: an employer may decide to stop contributing to a scheme; an employer may become insolvent and this may lead to the scheme being wound up; or the scheme s trustees may decide to wind up the scheme. When a salary-related scheme winds up, the trustees of the scheme have to try to pay what is owed to scheme members using the scheme s current funds (or assets). Sometimes there may not be enough funds to do this. When this happens, any shortfall becomes a debt the employer owes to the scheme. This allows trustees to take action to recover the debt. Regulations also make sure that assets are shared out as fairly as possible. In certain circumstances, members may have some or all of their SERPS (State Earnings-Related Pension Scheme) or State Second Pension restored for the period they were contracted out. 18

21 All of this helps protect the pension you have built up. But there is still a chance that you may get less than you expect if your salaryrelated scheme winds up. That is why the Government set up the Pension Protection Fund and introduced a new Pensions Regulator. The Pension Protection Fund The Pension Protection Fund was set up on 6 April 2005 to protect members of eligible salary-related schemes (including those that are not contracted out) by paying compensation if the pension scheme does not have enough funds to pay its pensions obligations and the employer becomes insolvent. If this happens, the Pension Protection Fund will pay: 100% compensation to people who have reached the scheme s pension age and to people under that age who are receiving a pension because their partner worked for the company and had died or had a pension awarded for ill health; or 90% compensation to people who do not fall into the categories above. However, there will be an overall limit on the total benefit paid. The Pension Protection Fund is paid for by charging eligible salary-related schemes. 19

22 The fund also takes over any remaining assets where the scheme is being wound up and does not have enough funds to meet its pensions obligations. From September 2005, the fund took over the functions of the Pensions Compensation Board and will continue to pay compensation to all types of occupational schemes (including money-purchase and mixedbenefit schemes) where there have been cases of fraud or of scheme assets being misused. If your salary-related scheme is being wound up and you want to find out more about how it affects your benefits, you can find out from the scheme trustees. If you are in any doubt about your position, you can get advice from an authorised financial adviser. But remember, if you do this you may have to pay. The Pensions Regulator The new Pensions Regulator was set up on 6 April 2005 and focuses on protecting the benefits of scheme members by concentrating on those schemes where the members are considered to be at high risk from fraud, poor management or poor administration. The Pensions Advisory Service can also give you more information about contracted-out 20

23 pensions see page 25 for details. You may also find Personal Pensions Your guide (PM4) and Stakeholder Pensions Your guide (PM8) helpful. See page 31 for details about how you can get copies of these guides. What if I am not happy with my pension scheme and need to take matters further? The Pensions Advisory Service can help you if you are having problems with your pension that your scheme managers or trustees cannot sort out. The Pensions Ombudsman can investigate complaints of poor administration from members of occupational pension schemes. See page 25 for details about how you can contact them. How does contributing to a pension affect my tax payments? You will usually get tax relief on your contributions to a non-state pension and it can also increase the amount of any Child Tax Credit or Working Tax Credit you or your partner may get. 21

24 As long as your contributions are within the limits set by HM Revenue and Customs, if you pay the basic rate of income tax of 22%, every 100 that goes into your pension fund costs you 78 (based on the tax year 2005/06). If you pay income tax at the higher rate of 40%, every 100 that goes into your pension fund costs you 60 (based on the tax year 2005/06). Even if you don t pay income tax, the Government will pay 22 for every 78 going into your pension, up to a combined total of 3,600 for the 2005/06 tax year. If you want to know more about stakeholder pensions or personal pensions and tax, please see Personal Pension Schemes (including Stakeholder Pension Schemes) A guide for members of tax-approved schemes (IR3). See page 27 for details about how you can get a copy of this leaflet. Making the pension tax rules simpler From 6 April 2006, there will be a new, simpler tax system for pension schemes. This is designed to make pension schemes more flexible and easier to understand. Pension providers and financial advisers will be able to tell you about this new system. 22

25 What if I intend to live abroad when I retire? If you intend to live abroad permanently when you retire, you will not get a yearly increase in your State Pension (including your additional State Pension) unless you live in a European Economic Area country or a country that the UK has an agreement with that allows for these increases (known as upratings ). To find out which countries these are, and how UK state pensions are paid to people abroad, please see Going abroad and Social Security Benefits (GL29). See page 27 for details about how you can get a copy of this leaflet. To find out what will happen to your contracted-out occupational, personal or stakeholder pension if you move abroad, you should ask either your employer or, if appropriate, your personal or stakeholder pension provider. 23

26 Where can I get more help? 24

27 Directory Where we refer to phone numbers that begin with 0845, they will be charged at the local rate based on current charges from BT landlines. Charges for calls from mobile phones and other networks may be different. The Pensions Advisory Service can give you information about any aspect of occupational, stakeholder and personal pensions. You can contact the Pensions Advisory Service if you are having problems with your pension that your scheme managers or trustees cannot sort out. You can contact them on from 9am to 5pm, Monday to Friday. Or, you can visit the Pensions Advisory Service website at You can also write to them at The Pensions Advisory Service, 11 Belgrave Road, London SW1V 1RB. Or, them at If the Pensions Advisory Service can t help you, you can take your complaint to the Pensions Ombudsman. You can contact them on from 9am to 5pm, Monday to Friday. You can write to the Pensions Ombudsman, 11 Belgrave Road, London SW1V 1RB. 25

28 Or, you can visit the Pensions Ombudsman s website at or them at enquiries@pensionsombudsman.org.uk If you have a question about contracting out of the State Second Pension, the National Insurance Contributions Office may be able to help, although they will not be able to give you financial advice. You can contact them on from 8am to 5pm, Monday to Friday. Or, you can visit the HM Revenue and Customs website at You can also write to the National Insurance Contributions Office, Contracted-Out Employments Group, Benton Park View, Newcastle upon Tyne NE98 1ZZ. If you live in Northern Ireland, you can write to the National Insurance Contributions Office (Northern Ireland), Corporation Street, Belfast BT1 3DP. The National Insurance Contributions Office is part of HM Revenue and Customs. Other publications you may find useful Personal Pension Schemes (including Stakeholder Pension Schemes) A guide for members of tax-approved schemes (IR3) 26

29 You can get this leaflet by calling HM Revenue and Customs Audit and Pension Schemes stationery orderline (answerphone) on at any time. Or, you can visit the HM Revenue and Customs website at guidance.htm You can also write to HM Revenue and Customs Audit and Pension Schemes, Yorke House, PO Box 62, Castle Meadow Road, Nottingham NG2 1BG. Going abroad and Social Security Benefits (GL29) You can get this leaflet from your nearest social security office or Jobcentre (details are in your phone book). Or, you can visit our website at A guide to State Pensions (NP46) This gives you more information about state pensions. You can get this guide from your nearest social security office or Jobcentre (details are in your phone book), or by calling us (see page 31 for contact details). Or, you can see a copy of this guide in the resource centre on The Pension Service website at 27

30 Employee s Guide to Minimum Contributions (CA17) You can get this leaflet by calling the National Insurance Contributions Office on from 8am to 5pm, Monday to Friday. You can also visit their website at Or, you can write to the National Insurance Contributions Office, Contracted-Out Employments Group, Benton Park View, Newcastle upon Tyne NE98 1ZZ. Our guides in this series A guide to your pension options (PM1) This guide gives a general summary of the pension system and suggests points you should think about. State pensions Your guide (PM2) This guide explains whether you are likely to get a State Pension and how we work state pensions out. It includes more details about the State Second Pension, including examples of how it can help people in different circumstances. 28

31 Where to get help and information Occupational pensions Your guide (PM3) You will find this guide helpful if you are working for an employer who runs a pension scheme and you are a member of the scheme or thinking of joining. Personal pensions Your guide (PM4) If you are thinking about a personal pension, this guide tells you the sort of questions you should be asking and how you can decide if a personal pension is right for you. Pensions for the self-employed Your guide (PM5) If you are self-employed, you have different options but you still have important decisions to make. This guide tells you how you can decide what will be best for you. 29

32 Pensions for women Your guide (PM6) As a woman, the pattern of your working life may be different from a man s. For example, you may be more likely to have a career break to raise a family. This guide gives you an idea of the options available, and what you should think about when you plan your pension. Contracted-out pensions Your guide (PM7) This guide gives you information about contracting out of (leaving) the State Second Pension if you are an employee. Stakeholder pensions Your guide (PM8) This guide tells you what you need to think about before taking out a stakeholder pension. It will help you decide whether this kind of pension is best for you. State pensions for carers and parents Your guide (PM9) If you have given up work or aren t earning very much because you are caring for someone, this guide may help you. It explains what to do to make sure you get as much State Pension as you can in the future. 30

33 To order copies of any of the guides in this series, you can call us on The line is open 24 hours a day. If you have speech or hearing difficulties, a textphone service is available on Or, you can write to us for any of the guides at Pension Guide, Freepost, RLXH-JUEU- GZCH, Northampton NN3 6DF (you don t need a stamp). You can also see these guides on our website at All guides are available in Welsh, on audio tape and in Braille. 31

34 32

35 For more information on any of the pension options below, please call or visit State Personal Occupational Women Self-employed Contracted-out Stakeholder Carers and parents 33

36 For more copies of this leaflet, or for a version in Welsh, on audio tape or in Braille, you can phone You can also read this leaflet on the internet at ISBN: Remember that this leaflet is only a general guide to contracted-out pensions and is not a full statement of the law. We have made every effort to make sure that the information in this leaflet is correct at the date shown on the cover. Crown copyright Produced by The Pension Service Printed in the UK October 2005 PM7 General enquiries (textphone users call )