State Pension Reform - The End Of Contracting-Out

Keywords: state pension reform, single-tier state pension

As part of its reform of the state pension system, the Government has announced that contracting-out will be abolished, probably from 2017.

Background

Contracting-out on a defined benefit ("DB") basis was introduced in 1978 at the same time as the state earnings-related pension scheme (which was later replaced by the State Second Pension ("S2P")). For service until 1997, schemes that contracted out on a DB basis were required to offer a guaranteed minimum pension ("GMP"), and for later service the benefits promised had to satisfy a so-called reference scheme test. Contracting-out on a money purchase basis was introduced in 1988, but has not been possible since 6 April last year.

On 14 January 2013, the Government published a White Paper setting out detailed proposals for the introduction of a single-tier ("flat rate") state pension, most likely from 2017 but not before then, after which the state pension will no longer include separate basic and S2P elements. The White Paper also announced that, as S2P will cease, schemes will no longer be able to contract out of it on a DB basis.

Proposed reforms

The White Paper contains the following announcements directly impacting occupational pension schemes:

DB contracting-out will be abolished when the new single-tier state pension is introduced. The Government will work with the pensions industry to set an implementation date for the abolition that allows employers to plan properly and for the abolition process to run as smoothly as possible; employers will be given a unilateral statutory power to change scheme rules for future service to offset the increased level of employer National Insurance Contributions ("NICs"). This statutory power will apparently allow employers to reduce future service benefits and/or increase member contributions, but only to the extent needed to offset the increase in employer NICs. This power will only be available for a limited period, and the Government will be consulting on whether there should be any further restrictions on the power; employers will have to consult members about any benefit or contribution changes they propose to make using the statutory power, though they will not have to consult about the fact that their schemes will no longer be contracted-out; the White Paper makes it clear that the new employer power will not be used in public sector schemes proper, but the Government will consult on...