End of contracting out brings extra pension costs

For employers with staff in public sector pension schemes, this extra cost will not be offset by higher employee pension contributions or any reduction in the pension benefits.

Until now many schemes paying salary-related benefits have been contracted out of SP2 which meant that participating employers and employees were entitled to pay a lower rate of national insurance contributions. The end of contracting out means that they will no longer be eligible for this lower rate. Employers will need to pay an additional 3.4% of earnings between the lower earnings limit (£5,824 for the 2016/2017 tax year) and the upper accrual point (£40,040 for the 2016/2017 tax year). Employees who are members of contracted out pension schemes will pay an additional 1.4% of their earnings between these 2 thresholds. If this applied in the current tax year, this could mean the employer paying up to an additional £1,163 a year for each employee who was previously contracted out and the employee paying up to an additional £479 a year.

The Pensions Act 2014 does include a power which allows the employer participating in private sector schemes to unilaterally amend scheme benefits in order to offset the costs of additional employer national insurance contributions. Employers can use this “statutory override” to either increase members’ contributions or to reduce the accrual rate of salary related schemes. It is also only available for 5 years.

However, this power is not available in respect of public sector pension schemes such as the Local Government Pension Scheme, the Teachers’ Pension Scheme and the NHS Pension Scheme. Employers will therefore have to fund these extra costs themselves.

At a time where many employers are feeling the squeeze, these unwelcome extra costs may lead employers to consider whether they wish to continue to participate in salary related schemes at all. Employers may therefore decide that they would prefer to close the scheme to new joiners or even to all members. Some employers, such as academies and arms-length management organisations, don’t have this choice as their staff have an automatic right to participate in the relevant public sector schemes.

For more information

If you wish to discuss consultation with staff about changes to benefits or contribution rates or scheme closures, please contact Doug Mullen.

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