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Contracted out? You haven't lost out, says Altmann
Pensions minister Ros Altmann argues those who are contracted out are being treated 'generously' under the new state pension system.
Pensioners who will not receive the full flat-rate state pension due to ‘contracting out’ are not losing out and have been ‘treated generously’, according to pensions minister Ros Altmann.
Contracting out is a complexity of the current state pension system but will not be allowed under the new flat-rate state pension. The state pension, under the old system, was split into the basic state pension and the state second pension (S2P).
In the late 1980s the government encouraged workers to ‘contract out’ of S2P meaning the national insurance contributions (NICs) they paid were rebated back to their workplace pension. This was seen as a good thing as it boosted workplace pensions but what many workers didn’t realise was that they were no longer building up NICs towards the state pension.
Fast-forward to today and many pensions who have worked for 35 years or more will find they do not qualify for the full £155-a-week rate on offer under the flat-rate state pension that will coming in in April.
MPs on the Work and Pensions Committee grilled Altmann on why individuals had been sold a lie of a flat-rate pension when not everyone was guaranteed to receive the £155-a-week.
Altmann said there was a lack of understanding around how NICs and the state pension were linked.
‘One of the shocking things we discovered…was the lack of knowledge among the general public on just what the state pension is. There was a significant proportion of people who did not realise there was any link between their NI record and the state pension,’ she said.
‘Where things have gone wrong is that everybody thinks it is a flat rate £155, £156 or whatever. The flat-rate bit is the build-up, so every year in the new system you are building up [to] a flat-rate amount.’
Contracting out has meant that some people have not built up that flat-rate amount as they have not paid full NICs.
Altmann said while NIC records would be taken into account when determining the new state pension for individuals, those who had contracted out needed to recognise they had paid less towards it than a person who had never been contracted out.
‘Your old NICs record will obviously take account of the fact that you would have paid lower NI if you opted out of part of your state pension,’ she said.
‘The only reason you were allowed to pay lower NI was so that you could build up a private pension instead of the state pension you were opted out of. It simply would not be reasonable or fair to other taxpayers to say: “We know you opted out of some and you have another pension somewhere else, but we are not going to count that”.’
While those who will miss out on the full flat-rate pension may not believe so, Altmann said individuals who were contracted out were being treated ‘generously’.
Those who retire after April will have their state pension calculated under both the old and new systems and given the higher of the two amounts. ‘We will not reduce anyone below the £119.30 [a week] level’ said Altmann, regardless of whether they had contracted out or not.
On top of this, those who have contracted out still have the opportunity to build up their NIC record through continuing to work or through buying more NICs.
‘Someone who has never contracted out may have reached the £155.65 level with well under 35 years of contributions, and they cannot keep going,’ said Altmann. 'They cannot keep adding to their state pension, whereas those who were contracted out are being allowed to. There is that group, and some of them have contacted me who will reach state pension age very soon after April 2016. They will have a guaranteed minimum pension that typically will have been very generously uprated, and that is the other area…[where] the new system does help people who were contracted out.’
Martin Tilley, pensions expert at Dentons, said those who were contracted out would benefit from the added contributions that were made to their workplace pensions and were not ‘losers’ in this sense.
Not only have they benefitted from investment growth on the bonus contributions in their workplace pension, they will also be able to take 25% of the contributions tax-free on retirement, and pass the pension on to their loved ones on death – something that cannot be done with the state pension.
Tilley said contracting out may have worked out as a better option for some people.
‘The state pension is a bit like buying an annuity, you are topping up the state pension and that is great if you live a long life and you get it but if you die then [contracting out] could be better value,’ he said.
‘If you were contracted out…your [contributions] would have gone in to your pension pot and even though your state pension will be reduced down what you get [from your workplace pension] is better than what you have given up. Then you get 25% tax-free, which you don’t get with the state pension, and you can leave your workplace pension to the people you care about, which you can’t do with the state pension.’
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