THOUSANDS of Scots in final salary pension schemes face a “stealth tax increase” next year as part of the ripple effect caused by reforms to the state pension.
The launch of the new single-tier state pension, taking effect next April, is designed to simplify the system and give women, the self-employed and those on low incomes a better chance of qualifying for a full state pension.
But as the big shake-up nears there are growing concerns over the number of people who will get less than they expect from the new arrangement.
It will also mean a cut in take-home pay for up to six million people in company final salary schemes, also known as defined benefit (DB) pensions.
Under the current system, extra benefits can be built up through the state second pension (S2P, which replaced the state earnings-related pension scheme in 2002). Millions of people in private sector final salary schemes were opted out of the S2P by their employer, getting better benefits through their company pension.
However, contracting out comes to an end when the new single-tier pension takes effect – and that also means the end of a national insurance rebate paid to workers in company final salary schemes.
The rebate – 1.4 per cent of band earnings (taxable pay between the lower and upper earnings limits, £5,824 and £42,385 a year in 2015/16) – means those who contracted out currently pay national insurance at 10.6 per cent.
From April 2016 they will pay the same 12 per cent rate as all workers, a move that amounts to a “stealth tax bombshell” for up to six million people, according to the GMB union.
Those affected and who have an annual salary of £15,000 will pay an extra £128 a year in national insurance. That rises to £268 for those earning £25,000 a year and to £408 for employees on a salary of £35,000, a substantial reduction in take-home pay.
“This extra tax on six million working people will come as a very nasty shock,” warned Brian Strutton, national secretary of the GMB. That will generate an extra £5.1 billion a year of revenue for the Treasury, the union estimates.
HMRC figures show that three-quarters of people reaching state pension age in the first two decades after 2016 will have been contracted-out at some point, noted Richard Libberton, private wealth manager at Anderson Strathern Asset Management.
“They also say that most will get more state pension as a result of the single-tiered pension,” he added. “Those who have been long term self-employed will benefit from the changes. The question is, will they be asked to pay for the benefit in future?”
Anyone worried about their national insurance contribution record and the amount of state pension they’ll get under the new system can ask for a state pension statement (by calling on 0800 731 7898 or going to www.gov.uk/calculate-state-pension).
“However, this should be done after the new pension kicks in in April 2016 as all contributions and credits up to the 2015/16 tax year will be recorded on their NI record. Thereafter, they should seek advice on future pension planning,” he said.
Employers will also lose their national insurance rebate, currently 3.4 per cent of band earnings. HMRC estimates that some 2,500 employers with open final salary schemes will be affected. It’s this that could ultimately have the greatest impact, predicted Malcolm McLean at actuaries Barnett Waddingham.
“This is a cost and therefore many employers with DB schemes in the private sector are looking to adjust the pension benefits offered in the scheme, to offset the increased national insurance bill,” he said.
That could mean a further acceleration in the rate of DB scheme closures.
“Many employers have already closed down their final salary schemes in the past on the grounds that they were already too expensive for them to support and some who have thus far persevered with their schemes may decide that they can’t simply accept this further cost falling on them,” said McLean.
The other options facing private sector employers hit by the national insurance hike include reducing the benefits paid to members and/or increasing the contributions that workers pay, according to Libberton.
“They will still need to consult the membership before any changes are made. Employers who decide to keep their schemes open to future accrual will no doubt be considering changes to offset increase national insurance cost,“ he said.
Meanwhile, the government has launched a drive to raise awareness of state pension changes, with pensions minister Ros Altmann admitting “the job of explaining to people how the reforms will affect them hasn’t been done well enough”.
The Institute for Fiscal Studies estimates that almost seven in 10 new claimants in the first four years will get less than the full amount.