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If you operate a contracted-out occupational pension scheme, you are entitled to deduct a lower rate of National Insurance contributions (NICs) from employees who join it and who are under State Pension age.
This guide sets out what a contracted-out scheme is and explains what you need to do if an employee joins or leaves one of these schemes.
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The NICs your employees pay build up an entitlement to receive a State Pension. There are two parts to the State Pension - the basic State Pension and the State Second Pension (which was previously known as the State Earnings-Related Pension, or SERPS).
Employees are permitted to opt out (or contract-out) of the State Second Pension if they join an approved occupational pension scheme instead. These schemes are known as contracted-out pension schemes.
When an employee joins one of these schemes they are entitled to pay a lower rate of NICs, known as a contracted-out rate. The specific rate that applies depends on which of the three types of contracted-out scheme the employee joins:
Joining a contracted-out scheme only affects NICs - it makes no difference to your deductions of PAYE tax from your employees.
Download a flowchart showing which NICs rates apply to which schemes (PDF 42K)
When you set up an occupational contracted-out scheme, HMRC will send you an Employer Contracting-out Number (ECON), which you will need to enter on form P35 when completing your Employer Annual Return (form P35 and forms P14) at the end of the tax year.
We also assign a Scheme Contracted-out Number (SCON) to each occupational contracted-out pension scheme. When completing your Employer Annual Return, the SCON must be entered on the form P14 of each employee who is a member of a Contracted-out Money Purchase scheme or a COMP Stakeholder Pension Scheme.
The SCON will be required on the P14 for tax years up to and including 2011-2012, as COMP and COMPSHP schemes will not exist from 6 April 2012. For further information see the section in this guide 'Changes to contracting-out from 6 April 2012'.
Please note that almost all employers are now required to file their Employer Annual Return online.
More about filing your Employer Annual Return
If an employee joins an occupational contracted-out scheme, you must start working out their NICs using the correct NICs category letter. This applies to all payments you make to the employee after they have joined the scheme - even if a payment relates to work carried out before they joined.
Download a flowchart showing which NICs rates apply to which schemes (PDF 42K)
There are no changes if your employee is contracted out into a salary related occupational pension scheme. The changes apply to Contracted-out Money Purchase Scheme and COMP Stakeholder Pension Scheme
From 6 April 2012, contracting-out of the additional State Pension (otherwise known as State Second Pension) will be abolished for certain kinds of pension. From this date you and your employee won’t be able to contract-out of additional State Pension through:
If your employees already pay into one of these schemes, you and your employee may be able to continue making contributions to the scheme. However, after 6 April 2012, HMRC will stop paying NICs rebates on earnings paid after 6 April 2012, into your scheme.
Instead, employees will automatically be brought back into and will start to build up their entitlement to the additional State Pension scheme. Employers and employees who have previously paid reduced rate NICs will then pay the standard rate of NICs instead.
More about additional State Pension for employees on the Directgov website (Opens new window)
If you operate more than one occupational contracted-out pension scheme and an employee transfers between them, you will need to do the following:
If an employee leaves your occupational contracted-out pension scheme but continues to be employed by you, you must start deducting NICs at the appropriate not contracted-out rate. This should be used for all payments to the employee after the date they stop being contracted-out, even if a payment relates to work carried out before that date.
If a contracted-out employee leaves your business you must notify us and treat any subsequent payments to the employee (such as outstanding salary or a bonus) as follows:
The rules that apply when a contracted-out employee leaves your business are detailed. For further information, call HMRC's Contracted-Out Pensions Helpline (see the further information section, below) or consult our publications CA14 and CA14A (you'll find links to both at the end of this guide).
When an employee reaches the State Pension age they no longer have to pay employee's NICs, but you must pay employer's NICs using NICs category letter C at the not contracted-out rate. This applies even if the employee was contracted-out before reaching State Pension age.
Note that reaching the State Pension age only affects NICs - there's no change to PAYE tax deductions.
Download publication CA41 containing NICs tables for category letter C (PDF 907K)
More about PAYE when an employee reaches State Pension age
If you have any further queries about operating an occupational contracted-out pension scheme you can call HMRC’s Contracted-out Pensions Helpline.
Find contact details for HMRC’s Contracted-out Pensions Helpline
You can also find more information about PAYE and contracted-out pension schemes on pages 65 to 67 of HMRC’s publication CWG2, 'Employer Further Guide to PAYE and NICs'.
Download CWG2, 'Employer Further Guide to PAYE and NICs' (PDF 490K)
Download HMRC’s guide covering COSR employees who leave your business (CA14) (PDF 872K)
Download HMRC’s guide covering COMP employees who leave your business (CA14A) (PDF 673K)
