Joining or leaving a contracted-out occupational pension

If you operate an approved contracted-out company 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.

On this page:

Reduced rate NICs for contracted-out pension schemes

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 company pension scheme instead. These schemes are known as Contracted-out 'defined benefit' schemes, sometimes called Contracted-out Salary Related schemes.

When an employee joins one of these schemes they and their employer are entitled to pay a lower rate of NICs, known as a contracted-out rate.

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 15K)

Top

Important reference numbers for contracted-out pension schemes

When you set up a company contracted-out scheme, HM Revenue & Customs (HMRC) will send you an Employer Contracting-out Number (ECON) and a Scheme Contracting-out Number (SCON).

Enter the ECON and SCON in your payroll records, so they are reported on every Full Payment Submission (FPS) and HMRC gets this information when you send details of payments made to employees in your contracted-out company pension scheme. Follow the links below to find out where this information must be put.

Reporting the ECON on your FPS

Reporting the SCON on your FPS

Top

Employee joins a company contracted-out scheme

If an employee joins a contracted-out company pension scheme, you must start working out their NICs using the correct NICs category letter - see the flowchart at the link below. 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 15K)

Directors

If the employee is a director, you must give special consideration to assessing their NICs when they join a contracted-out scheme. More information on this is in the HMRC publication CA44.

Download CA44, 'National Insurance for Company Directors' (PDF 1.3MB)

Top

Changes to contracting-out from 6 April 2012

From 6 April 2012, contracting-out of the additional State Pension (otherwise known as State Second Pension) was abolished for certain kinds of pension. From this date you and your employee cannot contract-out of additional State Pension through:

  • a personal or stakeholder pension scheme
  • a contracted-out money purchase company pension scheme, which is otherwise known as contracting-out on a 'defined contribution' basis

If your employees already pay into one of these schemes, you and your employee may continue to make contributions to these schemes. However, from 6 April 2012, the contracting-out status for these schemes was abolished and the availability of contracted-out rebates ended on 5 April 2012.

From 6 April 2012 employees were automatically brought back into, and started to build up their entitlement to, the additional State Pension scheme. Employers and employees who had previously paid reduced rate NICs started to pay the standard rate of NICs instead.

More about additional State Pension for employees on the GOV.UK website (Opens new window)

Top

Employee leaves your contracted-out scheme

If an employee leaves your company contracted-out pension scheme but continues to be employed by you, you must start deducting NICs at the appropriate not contracted-out rate. Use this rate 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. You should continue to report the year to date data for the contracted-out NICs category up to and including the last FPS for the tax year.

Top

Employee leaves your business

If a contracted-out employee leaves your business you must notify HMRC and treat any subsequent payments to the employee (such as outstanding salary or a bonus) as follows:

  • if the payment is made within six weeks of the employee leaving your business deduct NICs at the contracted-out rate
  • if the payment is made more than six weeks after they leave, deduct NICs using the not contracted-out rate

The rules that apply when a contracted-out employee leaves your business are detailed so for further information, call HMRC's Contracted-Out Pensions Helpline (see the further information section at the end of this guide) or consult HMRC's publication CA14 at the link below.

Download HMRC's guide covering COSR employees who leave your business (CA14) (PDF 872K)

Top

Employees over State Pension age

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. You should continue to report the year to date data for the contracted-out NICs category up to and including the last FPS for the tax year.

Note that reaching the State Pension age only affects NICs - there's no change to PAYE tax deductions.

Employee reaches State Pension age

Top

Further information

If you have any further queries about operating a company contracted-out pension scheme you can call HMRC's Contracted out Pensions Helpline.

Find contact details for HMRC's Contracted out Pensions Helpline

Top