Contracting out rebates for the five years beginning in 2007 will see a severe decrease for those aged 43 and over who contract out of the state second pension (S2P) into a personal pension.
The rebates announced by the Department of Work and Pensions (DWP) follow the publication of the Government Actuary’s report which sees the age-related rebate cap in defined contribution (DC) personal pensions fall from 10.5% to 7.4% in April 2007.
At the moment, the age-related cap affects people aged 54 or over, at which point their rebate is limited to 10.5%, and this is less than the actuarial value of the pension given up by contracting-out.
But the reduction in the ceiling announced by the government means from 2007, people aged 43 or over who have contracted-out will be limited to just 7.4% of the rebate.
Adrian Boulding, pensions strategy director at Legal & General, describes as a severe reduction but he points out it is not all bad news, however, as below the cap the rebates will be increased between 0.5% and 1.9% depending on a person’s upper tier earnings.
“The government have been a lot more generous to younger contracted-out people, so we have achieved some success with the consultation, but at the expense of older people. So come 2007, people aged 43 and over will have to look more seriously at whether they should be contracting back in,” says Boulding.
He adds the fall in the age-related rebate cap is not good news, particularly as the large majority of those contracted out are over the age of 43. And it won’t just be people hitting 43 in 2007 who will be affected, as those over the age of 54 who come under the current cap of 10.5% will also see the level of their rebate fall after 2007 to 7.4%.
In its announcement, the DWP also set out the rebates for final salary, or defined benefits (DB) occupational schemes, which will rise from 5.1% to 5.3% in 2007.
Stephen Timms, minister for pensions reform, says: “As we are in the process of reaching a long-term pensions settlement, it is responsible to take a cost neutral approach. The Pensions Commission made a number of recommendations in relation to contracting-out and it would be wrong for us to make decisions on this out of the context of our White Paper.”
But the Association of British Insurers (ABI) called the announcement of the rebates disappointing, with Chris Kenny, director of life and pensions at the ABI, claiming an opportunity has been missed to simplify the decision-making process and to spread the cost of future pension liabilities.
Kenny adds: “We are very disappointed the government has chosen to ignore our detailed arguments on the level of rebates. A simplified contracting-out system with attractive rebate levels to stimulate saving should be a crucial part of the new pensions settlement.”
Meanwhile, consulting firm Watson Wyatt warns the new rebates will fall more than £1.5bn short of the amount required to replace, on a risk-free basis, the state pension being given up.
It also claims as companies now have to go bust before they can wind up a DB scheme in deficit, the new rebates are effectively a tax on the amount owing, which is directly contributing to the closure of DB schemes.
Stephen Yeo, a senior consultant at Watson Wyatt, says for people contracted-out with personal pensions, or company money purchase schemes, the rebates will only provide a pension in excess of the S2P being given up if they are prepared to take considerable risks.
He adds: “Most individuals who are contracted-out will continue to be best advised to opt back in. It is widely acknowledged private pension provision is in difficulty. Although the government talk about encouraging private pensions, their actions suggest otherwise. In failing to increase the rebates they have missed an opportunity to give some real help to those wishing to provide their own pension.”
John Wigley, NAPF Strategic Adviser, Pensions Policy agrees the pensions system would be a lot easier to understand without contracting out. But says so long as contracting out exists, the rebates must be set at a level which adequately compensate pension schemes for the costs and risks they are taking off the Government’s hands.
He adds: “Instead, the new rebates have been set without taking into account how recent changes such as the introduction of the Pension Protection Fund have increased the cost of benefit provision and transferred risks from the Government to employers. For final salary schemes, a fair rebate level would be around 8% rather than 5.3%."
But the DWP does add it will consider whether the rebate rate needs to be reviewed again in light of any decisions on the long-term future of contracting-out made in the Pensions Reform White Paper.
So Boulding points out advisers should reassure any clients worrying about the new rebates as they will not apply until 2007, and that it is more important to make a decision on contracting-out for the current year if they haven’t already done so.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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