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Has your pension been cut by thousands of pounds?
Individuals who were contracted in to the state second pension may have lost out on thousands of pounds.
by Michelle McGagh on Jan 24, 2013 at 15:54
Employees who 'contracted in' to the state second pension could have thousands of pounds wiped off their pension with the introduction of the single-tier state pension.
The government plans to introduce a flat-rate state of pension of £144-a-week in 2017 abolishing the complex old system, the most confusing part of which is the 'contracting out' rules. But not only is it confusing, it could also have cost pensioners a lot of money.
What is contracting out?
Contracting out is not easy to understand, but simply put, it allowed employees and employers to pay lower national insurance contributions (NICs) and redirect the money saved by these lower contributions into a workplace pension scheme.
By contracting out employees lost the right to claim the second state pension (S2P) – which under the old state pension scheme helped top up the basic state pension. The money that was redirected into a private scheme is known as ‘protected rights’.
Individuals had to decide whether they wanted to be contracted in or out, and make a decision on where they thought the money would be most beneficial.
Those who decided to keep paying NICs at the full rate and receive the S2P were ‘contracted in’.
All change for pensions
Contracting out was abolished in April 2012 and under the new basic state pension rules, which will see the introduction of a single-tier pension of £144-a-week, S2P will be abolished.
Contracting out was a popular policy, and 80% of people have contracted out of the S2P at some point in their working lives. But those that are contracted out will now be brought back into the state system and made to pay full NICs, the increase equivalent to 1.4% of relevant earnings.
Although those that will be contracted back in may begrudge paying the extra NICs, Aviva corporate benefits head of policy John Lawson, said those who remained contracted in throughout their working lives will be the ones to suffer with the introduction of the single-tier pension.
Those who contracted out are still able to build up their entitlement to the full state pension of £144 but are also allowed to keep their protected rights – the money that built up when they opted out – meaning they receive double payments.
But those who contracted in will only be entitled to the £144-a-week, although they can keep any benefits they have accrued over this amount.
For example; take a person who was contracted out and then contracted back in seven years ago. If they had already gained entitlement to the full state pension then any money accrued over that entitlement will be paid as extra benefit, but if the person had not reached the full entitlement seven years ago when they were contracted back in then they are only able to use the last seven years of NICs to build up to the £144-a-week, not a penny more.
Lawson said the problem is that in the early 2000s, 12 years before the abolition of contracting out, regulatory pressure meant many pension schemes contracted savers back in automatically, and many of these will lose money.
He estimated that 2.5 million customers who had contracted out were then contracted back in following Financial Services Authority (FSA) advice that it would be in savers’ best interests.
Individuals who were contracted back in have lost on average, according to figures from the Association of British Insurers, £1,000 a year.
‘There are two million people who were contracted out and then back in by providers and they would have missed out on premiums of £2 billion a year which is £1,000 a year from their pension,’ he said.
‘A lot of people were contracted out seven years ago [following the FSA’s advice] so they could have missed out on seven years of £1,000.’
Lawson said that making a blanket decision to contract pension savers back in was the right thing to do at the time as the markets in the early 2000s ‘were in the pits’ and there was concern that poor performance meant savers were better off contributing to the S2P than not.
‘You can only give advice on what the world looks like at the time. The FSA and providers did what they thought was right at the time, although you can always look back and find fault,’ he said.
Lawson added that those who contracted in and those who were contracted out each had their reason to feel aggrieved, those who were contracted in because they may receive less and those who were contracted out because they will have to pay increased NICs.
‘We need to make sure that there are no big winners and no big losers, that [the flat rate state pension] is balanced and is based on give and take.’
More about this:
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- End of 'contracting out' could put your retirement income at risk
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