Pensions: government pushes for end to all contracting out

The Department for Work and Pensions (DWP) is considering extending the abolition of contracting out of defined contribution schemes to defined benefit pensions.

According to sources close to the DWP, pensions minister Steve Webb (pictured) is looking at ending contracting out across all private and public sector pension schemes.

It is thought that doing so would simplify the pensions system for employers, individuals and state departments and bring much needed extra revenue to the Treasury.

Contracting out involves national insurance (NI) contributions, which would pay for state second pension (S2P) benefits, being rolled into payments to an occupational scheme, rather than being paid to the Treasury.

Malcolm Small, head of portfolio and retirement planning at the Tax Incentivised Savings Association (Tisa), said the move would be welcome and argued it should pave the way for the S2P to be scrapped.

‘It has got to be the next step towards removing the means-tested S2P,’ he said.

‘No-one understands the S2P. We have heard before that Steve Webb wants a better basic pension and to end means testing, which takes away people’s incentive to save. Ending contracting out would mean people understand what they are paying NI contributions towards,’ he said. ‘If you are going to get rid of S2P, you have to get rid of contracting out.’

Contracting out from defined contribution, or 'money purchase', schemes is scheduled to end in 2012, subject to a consultation that ends in October. Small said that without ending contracting out across the board, it would cause confusion.

Under defined contribution schemes the end pension an individual receives depends on how much goes into the plan and on the investment returns it receives. By contrast, defined benefit, or 'final salary' schemes, the onus is on the employer to provide a pension linked to the individual's final salary or career average earnings.

Andrew Tully, senior pensions policy manager at Standard Life, said: ‘The [extra NI contributions] would improve the state pension. Without looking at the figures, I think the Treasury would save more money than it would have to spend on extra S2Ps. This would be the case even with the removal of means testing.’

Those with contracted-out pensions pay 9.4% in NI contributions instead of the full 11% rate. This is a problem for final salary pensions because it increases liabilities, which schemes are already struggling to cover, even with increased contributions.

The problem is worse for unfunded public sector pensions where the Treasury makes payments. It is estimated that ending contracting out in the public sector would save the state £6.6 billion a year.

In 2006, under a Labour government, the DWP published a white paper proposing the abolition of contracting out by 2030. But although the DWP has pressed ahead with removing contracting out on DC schemes, it has taken no action on private or public sector DB schemes.