Learn how the process of “contracting out” worked so that you can anticipate how it may impact the amount of state pension you receive in the future.

What exactly was being contracted out?

You had the option to “contract out” of the supplementary state pension when the former regulations governing the state pension were in effect.

Even if contracting out was terminated in April of 2016, your past participation in contracting out will still have an effect on the amount of state pension you receive under either the old or the new system.

In the past, in addition to the standard state pension, the state also offered a top-up pension known as the additional state pension, which was calculated according to the amount of money that one earned. It was first implemented in 1978 and was referred to as the state earnings related pension plan (Serps) at the time. In 2002, it was renamed the state second pension (S2P).

Prior to the adoption of the new regulations in 2012, workers had the option to “contract out” of this supplementary pension benefit. They handed up part or all of it in exchange for lesser or diverted National Insurance contributions and instead got additional pension from their occupational scheme or personal/stakeholder pension.

Prior to 1988, the only people who were eligible to contract out of their occupational pension plans were those who were members of a defined benefit (DB) occupational pension scheme. This provision was extended by the government in 1988 to include defined contribution (DC) or money purchase occupational systems as well as personal pensions.

During the first five years of the programme, the government contributed an additional two percent of your salary to the personal pension you had established for yourself. By the year 1992, almost 5 million people had switched from a Serps pension to a personal pension.

Here is the information that you require.

In the event that you were terminated from participation in a defined benefit programme

If you participated in a contracted-out defined benefit (DB) scheme, both you and your employer paid a National Insurance contribution that was slightly less than the standard rate. This is a reflection of the fact that neither of you contributed to the supplementary pension provided by the state. Only individuals who were participants in a defined benefit (DB) scheme were eligible to be contracted out and paid at a lesser rate between April 2012 and April 2016.

If you were contracted out of a defined benefit plan through a defined contribution plan, you were guaranteed a set amount of pension in exchange for the additional pension you were forgoing. When the government’s reforms to the state pension system went into effect in April 2016, contracting out on a DB basis was no longer an option.

If you were terminated from a defined contribution system, you are eligible for this.

Employees might be hired away from their jobs and placed in defined contribution or money purchase occupational plans beginning in April 1988 and continuing until April 2012.

If you contracted out through an appropriate personal pension, also known as an APP, or an appropriate stakeholder pension, also known as an ASP, both you and your employer continued to pay the same amount of national insurance contributions as before, but you were eligible for a rebate on some of this amount.

This sum was referred to as your national insurance rebate. After adding the tax relief and the rebate together, the total sum was invested, and then, at the time of retirement, it was utilised to pay benefits that were referred to as “protected rights” (see below).

Those who participated in a defined contribution (DC) scheme were required to pay the full rate of National Insurance beginning in April of 2012. Between the years 2012 and 2016, they contributed to the state second pension (S2P).

Which rights were safeguarded and why?

“Protected rights” were changed into “ordinary pension benefits” for members of DC schemes in 2012, which was the year when contracting out was made illegal for DC plans. Members of a contracted-out DC plan were entitled to certain advantages, and protected rights were one of those benefits.

The amounts that an employer was able to save as a result of lower National Insurance contributions and age-related rebates from HMRC were used to construct a member’s protected rights. Plans that were subcontracted out on the basis of protected rights were required to adhere to a variety of statutory conditions.

These conditions consisted of the following:

The protected rights had to be distinctly distinguishable from one another.
A pension for retirement that can begin being paid out starting at age 55 and can be paid out either as an annuity or as income withdrawals.
When a member’s annuity was based on protected rights, the annuity was required to include a survivor’s pension if the member was married or in a civil partnership.
A pension for your spouse or civil partner if you die before retirement

What implications does it have for my state pension if I have been leased out?

Those who became eligible for the state pension on or before April 6, 2016, will receive a lower “starting amount,” while those who became eligible on or after that date will receive a lower “starting amount.” Those who qualified for the state pension before April 6, 2016, will receive less or no additional state pension if they spent time contracted out.

Pension plans with predetermined benefits and those with guaranteed minimum payouts

The guaranteed minimum pension, also known as the GMP, is the minimum pension that was offered by an occupational pension system to employees who were let go from their positions with Serps between the dates of April 6th, 1978 and April 5th, 1997.

The computation for the GMP is a complicated process that is based on the contracted out earnings (also known as earnings that fall within the lower and upper earnings limitations) for each year of work that was contracted out.

During the two distinct time periods of 1978–1988 and 1988–1997, the GMP annual inflation-linked hikes were subject to different sets of criteria. Because of this, the GMP might increase at varying rates depending on when the supplemental pension was built up by the individual.

There is no obligation placed on your scheme to provide inflation-linked increases for service rendered prior to 1988. However, for service rendered between the years 1988 and 1997, they are required to provide inflation-linked increments, with a maximum increase of three percent. The Department of Work and Pensions (DWP) then recalculated the state pension that is payable each year. This ensures that a person’s entitlement to a guaranteed minimum pension is increased.

After 1997, there was a change in the law. Even if the employer chose to contract out the provision of pension benefits, they were still required to meet certain basic standards. Nevertheless, a’reference scheme test’ was something that the scheme needed to pass in place of GMPs. That is, the programme had to offer benefits that were at least comparable in value to those that you would receive if you were a member of a reference programme that was mandated by law.

When it comes to the up-rating of people’s new state pension, the government made the contentious decision, effective for people who retire after April 6, 2016, to no longer cover a portion of the inflation increases to guaranteed minimum pensions (accrued between 1988 and 1997). This decision was met with some opposition.

In practise, this indicates that increases to the guaranteed minimum pensions through the state pension will fall short of their full potential.

The performance of defined contribution pension plans

In contrast to defined benefit plans, there is no assurance that your final pension would meet or exceed the amount that you would have earned if you had opted to continue receiving the state second pension instead.

The ultimate sum will be determined by how well your investments have done in the pension plan, which is the account that your rebates have been funnelled into.

The fact that the funds were invested in a defined contribution scheme, on the other hand, means that you are eligible to reap the benefits of the increased flexibility offered by the pension freedoms, which include the possibility of accessing your funds at the age of 55.