Millions of people in retirement have money knocked off their state pension because they were once a member of a company pension scheme or took out a personal pension. These deductions go by a variety of confusing names – CODs, COPEs and GMPs amongst others. Yet few people have any idea where these numbers come from or even whether they are correct, and government websites offer few clues to the non-specialist.
Today, a new guide from consultants LCP aims to put that right. In a new paper “Why is money being deducted from my state pension?”, LCP explain the history of ‘contracting out’ of the state pension and how it affects your state pension today. Topics covered include:
- The basics of ‘contracting out’, including the differences between contracting out of a final salary type (Defined Benefit) pension and a pot of money (Defined Contribution) arrangement;
- How the rules around contracting out changed between 1978 when the system first started and 2016 when it was finally abolished;
- How contracting out affects those who come under the new state pension, explaining why even those with more than 35 years of NI contributions can fall short of the new flat rate, particularly in the early years of the new scheme;
Key points include:
- Contracting out via a salary-related pension was a deal. In simple terms, workers and employers benefited from a reduced rate of NI contributions. In return, the occupational pension scheme had to replace part of the state pension (the SERPS or earnings-related element) that the worker would otherwise have built up; between 1978 and 1997, the amount which the scheme had to provide instead of the SERPS pension was called a ‘guaranteed minimum pension’ or GMP;
- Contracting out of personal pensions (which ran from 1988 to 2012) worked in a different way; the worker benefited from a rebate of NI contributions which was paid into a personal pension and invested; whether the pension at retirement generated by that money was higher or lower than the state pension given up depended on things like the investment performance of the pot and annuity rates at retirement; most people in this kind of pension will have a deduction from their state pension which does not exactly match the private pension they built up in replacement; in some cases, the deduction will exceed the amount of private pension built up;
- Although contracting out was abolished for salary-related pensions in April 2016, past contracting out is still reflected in calculations for the new state pension; but those who have years of contributions from 2016/17 onwards can gradually ‘burn off’ the deductions for past contracting out; eventually they can built up a full new flat rate pension *in addition* to their contracted out pension. But in the early years of the new scheme, deductions for past contracting out can still leave them short of the full flat rate, even if they have 35 or more years of NI contributions.
- In the case of occupational pensions, in general the scheme as a whole was either contracted out or not contracted out; individual members did not make an individual choice about whether or not to be contracted out; this is why many people say they do not recall deciding whether or not to contract out – they simply joined a pension scheme which was run on a contracted out basis;
- State pension forecasts now contain a ‘COPE’ figure – the contracted out pension equivalent; this is an indication from the government of the occupational or personal pension which the individual *might* be getting from a contracted out pension arrangement; however, this is a ‘memorandum item’ and has already been used in the calculation of state pension. There is no need for people to do additional calculations using the COPE when they receive their state pension statement.
Commenting, Steve Webb, partner at LCP said:
“State pension statements and forecasts are full of jargon and abbreviations which can make little sense. The biggest confusions arise around contracting out – periods when individuals were members of a company or private pension which is meant to replace part of their state pension. Probably the most commonly asked question in pensions is ‘why is money being deducted from my state pension’, and we hope that this new guide will help to answer that question in plain English. The most important thing to understand is that contracting out was a deal where individuals benefited from lower NI contributions whilst in work in return for giving up rights to part of their state pension in retirement. Although contracting out was finally abolished more than five years ago, its impact can still be seen in the pensions of millions of people in retirement and yet to retire. We hope that this guide will help those people understand this impact and to check if their pension is correct”.