The government has provided further detail on the end of ‘contracting out’ of the second state pension and how defined benefit pension scheme members could have to pay £6,000 in extra national insurance contributions from 2016.
In today’s Budget, chancellor George Osborne confirmed that the £144 a week flat-rate state pension would come into effect in April 2016.
He explained that as the new single state pension would replace the two current state pensions, the state second pension would be abolished and people would no longer be able to contract out of it.
‘For employers that means paying the same employer national insurance as those without defined benefit schemes. Private sector employers can adjust their pension benefits to accommodate the extra cost; public sector employers will have to absorb the burden, as is always the case with tax changes,’ Osborne announced.
‘Public sector employees, and the relatively small number of private sector employees in defined benefit schemes, will from 2016 pay more national insurance then they do today. So they will pay the same rate of national insurance as the rest of the working population, and in return, they will get a larger state pension than before.’
He gave the example of how a 40-year old in 2016, who has always been contracted out, will pay an extra £6,000 in national insurance over the rest of their working life – and in return get an extra £24,000 in state pension over the course of their retirement.
Osborne called his announcement ‘a fair deal’ and ‘progressive pension reform’.
Ed Wilson, director in PricewaterhouseCoopers’ pensions team, comments: ‘The reforms mean the end of “contracting-out”, meaning employers who sponsor these types of defined benefit schemes, and employees in these arrangements, will face an increase in national insurance costs. Private sector companies can mitigate this cost by increasing employee contributions and/or reducing the generosity of their scheme. But employees in these schemes may still see a reduction in their take home pay of £300 a year on average due to their increased national insurance contributions.’
According to Wilson, this extra burden on employers and employees may mean that more defined benefit schemes close in the private sector.
The government also announced that the increase in the capped drawdown limit for pensioners of all ages from 100 per cent to 120 per cent would come into effect on 26 March.
Alastair Black, head of customer income solutions at Standard Life, says the 20 per cent uplift in income is good news, but says some people will have to wait up to a year to take advantage of the higher rate.
He explains: ‘The move back up to a 120 per cent income limit won't happen until the start of the individual’s next drawdown year after 25 March 2013, so some clients will have to wait up to a year to benefit from the uplift. But triggering an early income review by phasing more funds into drawdown can give an immediate income boost by locking into recent increases in gilt yields and rising markets - turbocharging the further 20 per cent increase when it does come.’
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