The Department for Work and Pensions’ reforms will allow anyone who contracted out of state second pension to rebuild full entitlement to the new flat rate pension provided they have 10 years left to retirement.
Public sector workers and other employees in contracted-out defined benefit and defined contribution schemes will also be able to rebuild full state pension having benefitted from better schemes as a result of contracting out.
One high profile pension expert who did not wish to be named said this means groups of employees who already have pensions will generally do better out of the reforms than currently unpensioned workers who are the target group for the government’s auto-enrolment programme.
The proposals guarantee anyone who contracted out and who will have 35 years National Insurance contributions a foundation pension of at least the level of the basic state pension of £107.45. But anyone who contracted out, whether into a personal pension or into a defined benefit or trust-based DC contracted-out scheme will be able to accrue more state benefits at the rate of £4.11 a year when the new system comes in from 2011.
That means anyone with 10 years or more still to retire can build up the same state pension entitlement as those who opted out and at the same time benefit from their contracted out pot.
Someone who has been contracted out into a personal pension since the power to do so was introduced in 1988 could have built up a pot of between £30,000 and £70,000 by now say experts, depending on charges and performance.
Five million civil servants stand to get an extra £1,924 a year more for a 1.4 per cent increase in employee NI contributions. This extra benefit will cost someone on an annual salary of £25,000 an extra £270 a year.
A median earner on £25,800 retiring in 2025 could have expected to receive state second pension of £3,900 a year under current rules, according to 2011 figures from the DWP, giving a combined state pension of around £9,000. If that median earner has remained contracted in to the state second pension throughout their life they will lose around £1,500 income a year. If in 2013 they are automatically enrolled into a scheme with an employer contribution of 3 per cent and employee contribution of 5 per cent on qualifying band earnings, they can expect to build a pension of £1,700, meaning the combined effect of auto-enrolment and state pension reform will leave them £200 a year better of after 22 years of saving.
A spokesperson for the DWP says: “Around 80 per cent of people have been contracted out for some period of their lives.”
Ros Altmann, director general of Saga says: “People who contracted out of state pension knew they were going to get a lower state pension as a result. To then give it them back is forcing extra costs on the taxpayer.”
Chris Curry research director at the Pensions Policy Institute says: “If you have remained contracted in throughout your working life then potentially you are going to get a lower pension than people who contracted out.”
John Lawson, head of policy, corporate benefits, Aviva says: “We are supportive of the changes but we will have to see what can be done to iron out wrinkles for those who lose out as there are groups that are clearly unfairly treated.”
Marian Elliott, head of trustee advisory services, Spence & Partnerssays: “There will be some questions over the implementation, particularly relating to ‘contracting out’ where an individual can currently divert part of their National Insurance contribution to an occupational pension scheme. Will all of the population now receive the same flat rate pension, despite different NI contributions over preceding years? This would be viewed as unfair but in terms of administration, it may be difficult to do anything else.”