The abolition of contracting-out has led industry figures to predict, again, the end of DB schemes in the UK, as Michael Bow reports
Private sector pension provision is dead – long live state benefits. That was the message the UK’s coalition government signalled in its 23 March Budget after the Treasury revealed its intent to end contracting-out for defined benefit schemes.
If scrapped, it would draw to a close a 50-year experiment to shift the burden of retirement provision from the state to the private sector.
Contracting-out – where a scheme provides benefits to members in place of the State Second Pension in return for lower National Insurance Contributions (NICs) – has remained one of the few financial incentives private firms have to provide final salary schemes to employees.
Its withdrawal will extinguish this incentive, and with it, the last remaining impetus for firms to provide defined benefit schemes to its workers.
The end of contracting out, or indeed any timetable for it was not mentioned explicitly in Chancellor George Osborne’s speech. Instead it was to be found deep within the text of the Budget Report. However, two key sections of Osborne’s speech did point to the possibility that the end was close for contracting out.
The first was the move to radically simplify the tax system by merging NICs and income tax. Amalgamating the operations of these taxes is expected to save money and bring efficiency savings. However, this would also make it impossible to contract-out because simply there would be nothing to contract-out of.
The second point was the proposed introduction of a flat-rate state pension merging basic state pension, State Second Pension and the top-up credit into a £140 ($224) a week state provision. While no definitive timetable has been put forward for this as yet, it had led to questions about if the state second pension was to cease, again there would be nothing to contract out of.
It’s also worth pointing out that if the DWP wishes to offer this flat-rate pension then it will need the money to fund it. The money that could be saved from providing tax breaks to firms who offer DB schemes – some £9.1bn according to the Office of Tax Simplification (OTS) – would provide a suitable pot of money to fund the state pension reforms.
Details of the proposal to end contracting out for DB schemes are still sketchy – and subject to lengthy 60-day consultation process – but experts say ending contracting-out is likely to increase the shift from DB to defined contribution in the private sector.
Aon Hewitt principal consultant Paul McGlone said: “The danger with the proposal to abolish contracting-out is that if companies are going to have to go through a painful consultation process anyway, then they may take the opportunity to simply close the scheme at the same time and use other arrangements to fulfil their forthcoming auto-enrolment obligations.”
This sentiment has been echoed across the industry, with experts claiming the move to simplify the system will hammer the final nail into the DB coffin lid.
PwC pensions partner Marc Hommel described contracting out as having: “mired pensions in a continued mystique, and made communication and administration horrendously complex.
“However, it has provided a financial incentive for a declining number of employers to perpetuate DB provision. The end of this incentive will make up the minds of those few remaining employers to accelerate DB closures.”
Firms who offer DB schemes currently get a tax rebate of 3.7% of payroll for having a scheme with contracted-out members. Ending contracting-out will mean it will cost firms 3.7% more of payroll to operate them, a burden many could shun in favour of complete closure.
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