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As from 6th April 2002 the system for contracting out changed with
the advent of the Second State Pension (S2P). As benefits from S2P
are based on credits over three bands of income, with varying percentages
of earnings counting for each, the methods of rebate have been modified.
Due to the different ways that schemes receive NIC rebates, each
has its own set of rules.
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Via Contracted Out Final Salary Scheme
Employees and employers rates of NIC are reduced at source and
the balance is applied to generate additional pension within the
main scheme. Employees pay 1.6% less NIC and employers 3.5%. This
rebate plus tax relief is credited to create Requisite Benefits
(previously GMP pre 6-4-97).
The NIC rebate alone is insufficient to cover the benefits given
up, based on the governments promise to match or exceed the benefits
offered by S2P’s predecessor SERPS. To deal with this and
to reduce the administrative burden on Occupational Pension administrators,
the government calculates the level of benefit lost by contracting
out, deducts the benefits created in the new arrangement and credits
the individuals S2P with a top-up amount to cover the difference.
This is only available for those that are eligible. For those earning between the Lower Earnings Limit (LEL) and Lower Earning Threshold (LET) £4,108 and £11,600 in 2004/05) the top-up is based on the assumption that they are treated as earning the equivalent of the LET.
Those earning up to the Upper Earnings Threshold (UET) (£26,000 in 2004/05) likewise will get a top up in line with the benefits due, but anyone earning higher than this will not receive a top-up.
Hence many who contract out, will not fully do so, as S2P continues
accruing, albeit at a lower level
- Via Contracting Out Money Purchase Scheme
The rebate has two elements.
A reduced contribution rate of NIC at source, as with the Final
Salary schemes but at a lower rate of 1.6% employee, 1% employer.
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An age related rebate paid via direct credit to the fund from the Inland Revenue, varying from 2.6% at age 15 to a cap of 10.5% from age 53.
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The following indicates the level of rebate available for sample ages.
Age on last day of previous tax year
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As with the Contracted Out Final Salary schemes, this does not fully
cover the liability and hence a member will also accrue a small S2P
credit whilst contracted out on the same basis as previously stated.
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Via Appropriate Personal Pension Plan
For all Appropriate Personal Pensions (APP) the DWP will pay a rebate 6 months after the end of the tax year directly to the scheme. With the change to S2P the table now has three elements equating to the three bands of earnings, which for the 2004/05 tax year range from 4.2% to 10.5%, but based on three different bands of accrual to equate to the way S2P operates.
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For appropriate personal pensions there are three bands of rebate
to mirror the three earnings bands of the S2P. The rebates are shown
in the table below:
| APP SCHEMES 2004/05 |
| Age on 5 April 2004 |
Band 1 |
Band 2 |
Band 3 |
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| 15 |
8.4 |
2.1 |
4.2 |
| 25 |
9.2 |
2.3 |
4.6 |
| 35 |
10.2 |
2.55 |
5.1 |
| 45 |
12.0 |
3.0 |
6.0 |
| 50 |
16.0 |
4.0 |
8.0 |