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BeeHive  >  BeeLines  >  Contracting-Out Rebates from 2007

Contracting-Out Rebates from 2007

The Government has just announced new contracting-out rebates that will apply from 2007. This is something we’ve been expecting as the rates must be reviewed and changed if necessary every five years by law and 2007 is the date set for that. From what the Government said yesterday rebates are to increase from 2007 - something that has been pretty much widely expected.

Contracting-out is what people are said to do when they give up the benefits of the State Second Pension (S2P - previously known as Serps) in return for rebates of, or reductions in National Insurance Contributions that are applied to their private pensions instead. In this way people are able to choose whether they want a pension backed by Government promises, or a pension backed by funded assets. It’s not quite that straightforward (although there’s no reason why it shouldn’t be), but that’s effectively the deal.

For such a deal to work in real life the amount of the rebate that is paid to people who contract-out of the State Second Pension scheme has to be of such an amount that it fairly reflects the value of the pension benefits foregone. That is why the rebates are constantly reviewed by law, although many people, me included, think five-yearly intervals are too long as the world changes quickly these days. However, that’s what we’re stuck with and that’s what yesterday’s Government announcement was all about.

Contracting-out works differently depending on the type of private pension an individual has. Where someone is in a final-salary occupational (or company) pension scheme the National Insurance Contributions payable by both the employee and the employer are reduced where people are contracted-out of S2P. At present where people are contracted-out of the State Second Pension the employee and the employer pay National Insurance Contributions reduced in total by 5.1%. The proposal by Government today is that this reduction should increase to 5.3% in 2007. That's an increase of about 4%, which is a step in the right direction I suppose, but nowhere near the 40% increase many have been saying is necessary*.

Where people contract-out of the State Second Pension on an individual basis with a Personal Pension or a Stakeholder Pension, they continue to pay the full level of National Insurance Contributions and the rebates are paid annually by HMRC to their pension provider for investment in their pension account. These rebates are made up of a flat rate bit and an age-related bit and take the form of cash payments (a bit like an annual pension transfer value). For those in money-purchase occupational schemes, the employee and the employer pay National Insurance Contributions reduced in total by the flat rate only of 2.6%. The age related rebate is then paid on an annual basis by HMRC just like for Personal Pensions. It was proposed yesterday that the level of the age related rebates should be increased from 2007 by between 0.5% and 1.9%, again meagre increases. Not only that, but in addition there is a maximum level of age related rebate capped at 10.5% from age 55 (although at ages 59 and 60 only, it’s slightly lower). This capping and the fact that different rebates apply at different ages and to different earnings bands is what currently confuses the hell out of merely normal people and gives those who are contracted-out something like an A-Level maths question to struggle with when deciding whether to remain contracted-out once they’ve hit their mid-fifties. That’s a problem that after 2007 will hit more people at an earlier age as the announcement today also says the capped level of the age related rebate will drop from 10.5% to 7.4% as part of this five-yearly review. Quite why I don’t know, but that’s what they’re saying.

However, and to make things more uncertain still, the announcement from the Government yesterday also points out that the recent report from the Pensions Commission made some recommendations of its own regarding the future of contracting-out and the Government is saying here that its response to that report (a likely White Paper containing yet more pension reform later this year) is not constrained by yesterday’s announcement. What they’re saying about this is that we shouldn’t take yesterday’s announcement as meaning that the Pensions Commission’s views on contracting-out have been binned (you’ll remember they want to stop people contracting-out on an individual basis, but leave people in final-salary occupational pension schemes alone). So if this year’s White Paper completely changes contracting-out, or even bans it, the fact these new rates have been published for 2007 onwards will be irrelevant.

Basically, the message is that rebates might be going up from 6 April 2007, although not by very much, but contracting-out might be fundamentally changed in the meantime anyway. You couldn’t make it up, could you?

Question 9822

Steve Bee

3 March 2006

Any research and analysis has been provided by us for our own purposes and the results of it are being made available only incidentally.

* The Independent, 3 March 2006, page 53, 'Government ignores pension rebate pleas'


1. DWP Press Release 2 March 2006 - Quinquennial review of contracted out rebate rates

2. A New Pension Settlement for the Twenty-First Century - The Second Report of the Pensions Commission, 30 November 2005

3. Statutory Instrument 2001 No. 1354 - The Social Security (Minimum Contributions to Appropriate Personal Pension Schemes) Order 2001

4. Statutory Instrument 2001 No. 1355 - The Social Security (Reduced Rates of Class 1 Contributions, and Rebates) (Money Purchase Contracted-out Schemes) Order 2001

5. Her Majesty's Revenue and Customs, leaflet E12(2005)(2) - PAYE and NICs rates and limits for 2005-2006