Malcolm McLean: The state pension’s surprising generosity to contracted-out DB members

McLean-Malcolm-700.jpgThe new state pension is surprisingly generous for members of contracted-out final salary schemes says Barnett Waddingham senior consultant Malcolm McLean

Royal London has issued a new leaflet explaining the various ways individuals might be able to cost effectively increase their state pension entitlements by the purchase of voluntary national insurance (NI) contributions. This is a very comprehensive leaflet on what for many people has long been a very complicated and confusing subject.

What the content does expose, however, is the rather surprising generosity of the new state pension scheme for members of contracted-out final salary schemes – mainly in the public sector – in stark contrast to those in other schemes who didn’t contract out and spent the bulk of their career paying into the state second pension instead.

As the leaflet explains, members of contracted-out final salary schemes would normally have a reduced pension “starting amount” at the commencement of the scheme on 6 April 2016 to take account of the lower rate of NI contributions previously afforded to both employers and employees in consequence of foregoing their right to the state second pension. They also are provided with a “guaranteed minimum pension” element as part of their private pension. Now, however, they can claw back the contracting-out deduction and build their state pension up to the full rate by either continuing to work and paying NI contributions in the normal way or alternatively, if necessary accruing extra pension by the purchase of voluntary NI contributions on extremely financially favourable terms.

In contrast for older workers with little or no contracted-out pension service a combination of their basic and state second pension entitlements will often produce a starting level for the new pension at 6 April 2016 at, or even slightly higher than, the flat-rate figure of £155.65. They will not be allowed to increase this further despite still being liable for full rate NI contributions whilst continuing to work right through till their state pension age.

There is in consequence a very un-level playing field between the two types of workers in contracted-out and contracted-in schemes. There are also potential heavy costs for the Government with tens of thousands of public sector workers with a current job retirement age of 60 who will now be able to increase their state pensions up to the full rate at their state pension age of 65 or 66 by making great value voluntary NI contributions at subsidised cost.

In these circumstances it is extremely unlikely that the Government will extend the concessions given to contracted-out scheme workers to all other workers and may indeed look to make savings by, for example, substantially increasing the purchase cost of voluntary NI in future years.