Know your legal obligations on pensions

Contracting out of the State Second Pension and paying Additional Voluntary Contributions

Providing that a company pension scheme meets certain conditions, it can be used to contract employees out of the State Second Pension (formerly SERPS).

Employers providing such schemes pay a lower rate of NICs for those employees who join their schemes, and employees themselves also pay reduced-rate contributions. If the scheme is contracted out on a money purchase basis, HM Revenue and Customs will also pay an additional age-related rebate direct to the scheme for investment on behalf of the employee. This is to compensate for the State Second Pension given up by the employee.

Employees who join an occupational scheme that is contracted out will be automatically contracted out of the State Second Pension. As with any occupational scheme, whether joining it is the best option depends on each individual's personal circumstances, such as working patterns and pay.

Where an employee contracts out of the State Second Pension with a stakeholder or personal pension plan, both the employer and employee continue to pay NICs at the full rate. At the end of each tax year, HM Revenue & Customs pays a rebate of NICs plus tax relief on the employee's share of the rebate directly into the pension fund for investment on behalf of the employee. Whether this type of pension is best depends on each individual's personal circumstances such as work patterns and pay. It also depends on their attitude to risk, as there is no guarantee that the contracted-out pension will be as good as or better than the State pension given up.

Since 2002, employees who contribute to a contracted-out occupational, personal or stakeholder scheme may get some State Second Pension for the year in which they contribute. This is because of more generous State benefits for lower-income earners and is intended to prevent them being put at a disadvantage when they contract out.

Additional Voluntary Contributions
If any member of an occupational pension scheme wishes to increase their pension provision, the employer must ensure there is a way for them to make extra contributions, known as Additional Voluntary Contributions (AVCs).

For members of Defined Benefit schemes, AVCs can go toward the purchase of additional years. Alternatively, the extra contributions could be put into a personal pension or a stakeholder pension. See the page in this guide on occupational pensions.

From 6 April 2006, employers operating occupational schemes will no longer be required by law to make this provision. However it is expected that many will continue to do so on a voluntary basis.

Subjects covered in this guide

• Introduction
• Occupational pensions
• Personal pensions
• Stakeholder pensions
• Contracting out of the State Second Pension and paying Additional Voluntary Contributions
• Must I provide a stakeholder pension?
• Providing a stakeholder pension - key steps

 Print This Page

Source - Business Link; Crown Copyright.