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