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UK rebates for contracting out are insufficient

UK- New rebates for ‘contracting out’ of the UK state second pension to be introduced in April are inadequate to cover the cost of replacing the forgone state pension according to the consultant William M. Mercer.

The stated long-term aim of the UK government is to pass increasing responsibility for pension provision to the private sector. But, says Dick Strattan, worldwide partner at Mercers, the new rebates are almost certain to produce the opposite effect.

"In the next five years we may see a reduction of as many as three million in the number of contracted-out individuals - shifting responsibility back to the State," he says.

Contracting out is the mechanism by which individuals, and employers on their behalf, replace part of their state pension entitlement with private provision.

According to Strattan, the rebates and terms offered by the government are meaner than when first introduced in 1978. “This has seriously called into question the financial benefits of contracting out.

"The new rebates fail to take proper account of current market conditions such as lower interest rates and investment returns and, on our calculations, account for considerably less than the full value of the State pension forgone - in some instances, arguably as little as half,” he says.

The real impact from the new rebates will come from new DC schemes as most are likely to be set up on a contracted in basis. But, says Strattan, it’s not just employers who will be having second thoughts. In future, members of stakeholder and personal pension schemes are much less likely to contract out on an individual basis.

"The government must think seriously about the implications of these rebates on the balance of state and private provision. If it genuinely wishes to promote private funding ahead of State provision, it will need to rebalance the contracting-out equation, " he says.

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