The National Insurance contribution rebates available to members of contracted-out defined benefit pension schemes – and to their employers – are to be reduced with effect from 6 April 2012 from 1.6% to 1.4% (for the employee) and from 3.7% to 3.4% (for the employer).
From the same date the fixed rate of revaluation applied to Guaranteed Minimum Pensions in deferment will rise from 4% per annum to 4.75% per annum.
Background
Since 1978 defined benefit pension schemes have been able to contract out of the State Second Pension (S2P, previously SERPS). Members of such schemes build up no entitlement to S2P during their membership but, in return, they pay lower National Insurance (NI) contributions, as do their employers. These schemes have to meet a quality test, in terms of the benefits they provide, which is intended broadly to ensure that the resulting benefits are greater than the S2P given up. Prior to 1997 there was also a more specific test: part of a member’s pension entitlement was deemed “Guaranteed Minimum Pension” or “GMP”. GMPs are intended to be similar in value to the SERPS benefit given up and they are subject to certain rules that do not apply to the balance of a member’s benefit from the pension scheme.
Every 5 years the Government Actuary has to produce a report for the Government, setting out his recommendations for the next 5 years as regards:
- the rate of NI rebate to be granted to individuals who are contracted out of the State Second Pension (S2P) through a defined benefit pension scheme and to their employers and
- the rate at which Guaranteed Minimum Pensions should be revalued for members who leave such schemes during the next 5 years.
National Insurance Rebates
The Government Actuary has calculated the value of S2P benefits forgone by members of contracted-out scheme using three different sets of assumptions:
- a best estimate approach, which is designed to produce an rebate that is as likely to be too high as it is to be too low,
- a “prudent ongoing funding” approach – designed to produce a rebate that reflects the reserve that a pension scheme might hold in respect of a similar level of benefit – and
- a “self-sufficiency” approach, which is designed to produce a rebate that is very likely to be sufficient.
After allowing for the acceleration in increases to the State Pension Age in the Pensions Bill, the resulting rebates are 4.8%, 6.2% and 10.4% respectively. The Secretary of State decided that the best estimate approach was the appropriate one to adopt and so put forward legislation reducing the rebates to 1.4% (employee) and 3.4% (employer), down from their current levels of 1.6% and 3.7% respectively.
GMP revaluation
The Government Actuary recommended that the rate of revaluation of GMPs be raised to 4.75% pa (from 4.0% pa). The Department for Work and Pensions has just issued a consultation paper and draft regulations, incorporating the recommended rate of revaluation for individuals leaving contracted-out defined benefit schemes between April 2012 and April 2017.
Comment
Both these changes make life more expensive for contracted-out defined benefit schemes – and for their members. Both members and employers will see their NI contributions rise with effect from next April. Furthermore, deferred pensions for members who leave service between April 2012 and April 2017 will have to be revalued in deferment at a higher rate than for members who leave before April 2012, to the extent that they have benefits earned prior to 1997.
Employers who are considering closing their (contracted-out) defined benefit schemes to future accrual in the near future should evaluate the cost of delaying this decision beyond 5 April 2012! Yet another nail in the coffin …