Comparable benefits in return for lower National Insurance Contributions

In 1988 it was possible for employees to contract out of the State Earnings-Related Pension Scheme (SERPS), now called the State Second Pension (S2P), where their work scheme did not do this for them already, and set up a form of Personal Pension Plan called ‘Protected Rights’.

Protected Rights are pension funds built up with contributions paid by the government into a Money Purchase or Defined Contribution pension scheme when an employee decides not to participate in S2P (or its predecessor SERPS).

Occupational Final Salary schemes (also known as Defined Benefit schemes) have been able to do this for a much longer time period. Such a scheme provides comparable benefits to the Additional State Pension in return for lower National Insurance Contributions.
Companies could also contract out via a Money Purchase scheme on a similar basis. The scheme would then be called a Contracted Out Money Purchase Scheme or COMP Scheme.

However, from 1988, contracting out was also possible for employees who were either in a contracted-in occupational scheme or in a personal pension.

Employees who contracted out paid the full National Insurance rate as normal and the Department for Work and Pensions repaid some of it in the following tax year, to the plan of the employee’s choice.This money was invested as the employee chose from the range of funds made available by the insurance company they were using.

Building up your entitlement to an extra pension

If you are in work, you may also be building up entitlement to the Additional State Pension. The Additional State Pension, or State Second Pension (S2P), is paid in addition to the Basic State Pension. Your entitlement to the Additional State Pension, whether from SERPS (State Earnings-Related Pension Scheme) or S2P, is calculated when you claim the Basic State Pension.

The Additional State Pension is based on your earnings in tax years from April 1978 up to the last complete tax year before you reach state pension age.

Between April 1978 and April 2002, this extra pension was called SERPS. Since April 2002 it has been called S2P. The calculation of S2P is more generous for low and moderate earners, who receive proportionately more from the S2P. Also, since April 2002, it has become possible for people who are carers, or have a long-term illness or disability, to qualify for the Additional State Pension.

All employees who earn more than the lower earnings limit for the relevant tax year qualify for the Additional State Pension unless they join an occupational or personal pension scheme that is contracted out.

If you are a carer, you can build up your entitlement to Additional State Pension – for example, if you receive Child Benefit and look after a child under six years old; if you are entitled to Carer’s Allowance; or if you look after a sick or disabled person and are receiving Home Responsibilities Protection.

Self-employed people do not qualify for Additional State Pension.

‘Qualifying years’ credited throughout your working life

The Basic State Pension is a government-administered pension. It is based on the number of qualifying years gained through National Insurance Contributions (NICs) you’ve paid, are treated as having paid or have been credited with throughout your working life.

The full Basic State Pension is £97.65 a week (2010/11). The current state retirement age for men is age 65, and for women it is changing. The state retirement age gradually increases to age 65 for women born between 5 April 1950 and 5 April 1955. This change started on 6 April 2010 and finishes on 5 April 2020.

This also has an effect upon Pension Credit for both men and women, as it moves the Qualifying Age (QA) to 65 over the next ten years from 6 April 2010.

The state retirement age for men and women will change again from 6 April 2024, moving everyone’s retirement age gradually to 66, then in 2034 towards 67 and in 2044 towards 68. The rules for building up your Basic State Pension have also changed for those people retiring after 6 April 2010.

From 6 April 2010, men and women who reach state retirement age now need 30 qualifying years to obtain the maximum Basic State Pension. If you have less than 30 years, you receive a proportion, for example, 15 years equals 50 per cent of the maximum pension.

A qualifying year is a year when you paid enough NICs or were credited with NICs, for example, if you were receiving jobseeker’s allowance or child benefit.

From 6 April 2010 there is now no minimum number of qualifying years. Before this date you were required to have at least 25 per cent of the maximum requirement to qualify for any pension.

The biggest change in pension legislation in a lifetime

The introduction of Pension Simplification legislation on 6 April 2006 (A-Day) brought about the biggest change in pension legislation in a lifetime with the following aims:

– to reduce the complexity of pensions

– to offer simpler and more flexible retirement arrangements

– to encourage saving for the future

Since 6 April 2006, simpler rules have been applied to both personal and occupational schemes. The rules allow most people to pay more into their pension schemes and on more flexible terms than before.

The rules for claiming tax relief on your pension contributions are also more flexible, though tax charges will apply if you go above certain allowances.

You can get tax relief on contributions of up to 100 per cent of your earnings (salary and other earned income) each year, provided you paid the contribution before age 75.

You can now contribute as much as you like into any number of pension schemes (personal and/or occupational) each year. There is no upper limit to the total amount of pension saving you can build up. But the amount you save each year towards a pension is subject to an ‘annual allowance’.

From April 2009 a ‘Special Annual Allowance’ was introduced to stop people making large additional pension contributions and getting higher rates of tax relief on them ahead of April 2011. The Special Annual Allowance will affect you if all of the following apply:

– your total pension savings, including employer contributions, are more than £20,000

– you change the amount you normally save towards your pension on or after 22 April 2009

– your income is £150,000 or more in the current or either of the two previous tax years

Your Special Annual Allowance is normally £20,000 less your normal pension savings. You have to include any amount by which your pension savings have gone over your Special Annual Allowance on your tax return.

The government also announced that from 9 December 2009 the Special Annual Allowance applies if your income is £130,000 or more. The allowance will apply in the same way as for people whose income is £150,000 or more, except that it will apply in relation to changes you make to the amount you normally save towards your pension on or after 9 December 2009. This restriction will apply until 6 April 2011.

For the tax year 2010/11 the government announced new pension rules as part of their ongoing spending review and the promise to simplify and curtail the current pension contribution regime.

The maximum pension contribution limit will be reduced to £50,000 (down from £255,000). Investors will benefit from tax relief at their highest marginal rate – that is, a basic rate taxpayer will receive 20 per cent tax relief, a higher rate taxpayer 40 per cent and a 50 per cent taxpayer 50 per cent relief.

The current Lifetime Allowance will also be reduced from April 2012. The full Lifetime Allowance will be reduced to £1.5m, down from £1.8m. When you start to draw your pension, HMRC will apply a recovery charge to the value of retirement benefits that exceed the Lifetime Allowance. The amount will depend on how you pay the excess.

The 2006 rules introduced a Lifetime Allowance test. This means that the total value of the benefits built up in your pension fund/s by you and/or your employer will be tested. This includes investment growth. The test will take place when you start drawing your benefits or when you reach age 75 (or age 77 for those members who reach their 75th birthday on or after 22 June 2010). In this case, tax would be payable as if you were drawing an income from the pension. You must become entitled to a lump sum before you reach age 75 (or age 77 for those members who reach their 75th birthday on or after 22 June 2010).

More ways of taking your pension income

There are now four choices:

– take a scheme pension – a secured pension for life paid out of the scheme assets or purchased from an insurance company

– buy an annuity (an investment that provides a regular income for life)

– draw an income directly from your pension fund as an ‘unsecured pension’ before age 75 (or age 77 for those members who reached their 75th birthday on or after 22 June 2010)

– draw an income directly from your pension fund as an ‘alternatively secured pension’ from age 75 (or age 77 for those members who reached their 75th birthday on or after 22 June 2010)

All types of pension schemes are now allowed to pay a tax-free lump sum of up to 25 per cent of the overall value of your benefits, provided there is provision in the scheme rules, to an overall maximum of 25 per cent of the Lifetime Allowance. You are not entitled to a tax-free lump sum once you reach age 75.

If you’re a member of an occupational company pension scheme, you no longer have to leave your job to draw your lump sum and a pension. You may also be able to draw all or some of your lump sum and pension while still working full or part-time for the same employer, depending on your pension scheme’s rules.

From 6 April 2010, the minimum age at which you were able to take your company or personal pension increased from 50 to 55. However, you may still be able to take your pension before age 55 in certain circumstances, for example, if you are unable to work due to ill-health.

Between 2010 and 2020 the minimum age at which women will be able to get their State Pension will gradually rise from 60 to 65. State Pension age will also increase for both men and women from age 65 to 68 between 2024 and 2046.

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