Contracting Out

• Topic 01

  Contracting Out

  27 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. A trustee of a DB scheme is reviewing the implications of contracting out having ended in April 2016. The scheme had been contracted out since 1980. Which of the following most accurately describes the scheme's ongoing obligations?

   • A
     The scheme's only ongoing obligation is to notify DWP of former contracted-out members; no benefit adjustments are required
   • B
     The scheme must still provide GMP for service from 1978–1997, meet any Reference Scheme Test obligations for 1997–2016 service, and complete GMP equalisation; NI rebates ceased but benefits already accrued remain
     Correct answer
   • C
     The scheme must pay members a lump sum equal to the NI rebates they lost from April 2016 onwards
   • D
     With contracting out ended, the scheme has no further obligations related to SERPS or GMP; all benefits are calculated solely under the scheme rules
   Explanation

   The end of contracting out in April 2016 only stopped the accrual of new contracting-out rights and the payment of NI rebates. Benefits already accrued (GMP for 1978–1997 service; benefits meeting the Reference Scheme Test for 1997–2016 service) remain as ongoing obligations. The scheme must continue to: calculate and pay GMP correctly; apply the correct revaluation and increase rules; and complete GMP equalisation. The end of contracting out does not extinguish historical GMP liabilities.

2. Is it still possible to contract out of the State pension today?

   • A
     No — contracting out was suspended in 2016 but may be reintroduced in future
   • B
     Yes — contracting out is still available through employer-sponsored DB schemes
   • C
     No — contracting out was never available to individuals; it applied only to employers
   • D
     No — contracting out was abolished; DC/personal pension contracting out ended in April 2012 and DB contracting out ended in April 2016
     Correct answer
   Explanation

   Contracting out of the State pension is no longer possible. DC and personal pension contracting out ended on 5 April 2012. DB occupational scheme contracting out ended on 5 April 2016 when the New State Pension replaced the old State Second Pension. Since the NSP is a flat-rate pension with no earnings-related element, there is nothing to contract out of.

3. A client contracted out of SERPS/S2P through a DB scheme for their entire working life (1980–2016). Their NSP starting amount calculation gives a contracted-out deduction of £120 per week, resulting in a starting amount of £80 per week. The full NSP is £221.20 per week. They have 3 post-2016 qualifying years. What is their NSP entitlement?

   • A
     The contracted-out deduction of £120 is deducted from the full NSP (£221.20), leaving £101.20; post-2016 years are irrelevant
   • B
     Starting amount (£80) plus 3 post-2016 years at £221.20/35 = £6.32 per year (£6.32 × 3 = £18.96) giving approximately £98.96 per week; they cannot reach the full NSP without many more post-2016 years
     Correct answer
   • C
     The client receives the full NSP because they were contracted out for more than 35 years, entitling them to the maximum
   • D
     The client receives nothing because the contracted-out deduction has reduced the starting amount below the minimum qualifying threshold
   Explanation

   The starting amount is £80 (below the full NSP of £221.20). Each post-2016 qualifying year adds £221.20/35 = £6.32 to the pension. With 3 post-2016 years: £6.32 × 3 = £18.96. Total NSP = £80 + £18.96 = approximately £98.96 per week. To reach the full NSP of £221.20, the client would need an additional (£221.20 − £80) / £6.32 ≈ 22 more qualifying years after April 2016. This illustrates how a significant contracted-out deduction can make the full NSP very difficult to achieve for members with long pre-2016 contracted-out service.