Pensions 

How to help clients understand contracting out

This article is part of
How to make sense of GMP clawback

How to help clients understand contracting out

How does contracting out work - and how does a scheme member know if they've contracted out/been contracted out?

The issue around clawback affects pensioners who have been contracted out of occupational pension schemes. 

In a nutshell, Kay Ingram, director of public policy for LEBC, describes this as schemes where both employer and employee have paid a reduced rate of national insurance (NI) while the member was working. 

The state pension is made up of two tiers - the flat-rate basic state pension, and the second, earnings-related tier, which depends on earnings levels and NI contributions. This is the part which schemes or individuals could opt out of when they contracted out. 

Effectively the member gets a lower state pension, in return for the lower NI payment. But given the paucity of information often coming from employers' pension schemes, coupled with the sometimes interminable language around pensions, how do scheme members necessarily know whether they have been contracted out? 

Firstly, if the client knows when they were in a defined benefit (DB) scheme, this is a good place to start investigating, as there was a certain timeframe in which DB schemes could choose to opt out of the additional state pension. 

As Keeley Paddon, head of technical for the SimplyBiz Group, explains: "Between 1978 to 1997, DB schemes could choose to opt out of the additional state pension and accrue GMP instead.

"The benefit of doing so is that both the employee and employer paid reduced rates of NI in lieu of an additional guaranteed pension."

Ms Ingram explains: "Pensions accrued from 1978 to 1997 may be contracted out in this way and so pensioners who were in final salary pension schemes between these dates are affected. This applies to both public sector and private sector occupational schemes."

Documentation needed

Checking whether your client's scheme is affected therefore relies on dates, but rather than wait for a begging letter to land on the doorstep, there are ways of finding out whether individuals had indeed opted to contract out, or whether their scheme contracted them out of the earnings-related contributions.

John Lawson, head of policy for Aviva, points out: "A member should know they have been contracted out because they will have paid lower rates of NICs while contracted out and they will have received a lower state pension."

However, it's worth checking with the documentation provided by the pension scheme.

Because GMPs have valuable revaluation rates every year, up until the scheme's normal retirement age (NRA), there should be documentation from the end of each tax year available to show what entitlements individuals may have. 

Individuals who have been contracted out through such schemes will have an element of GMP shown on their benefits statements - if they still have the documentation, that is.