Earnings Factor Calculation

Sixtiesman

Hi everybody,

I wonder if anybody can answer what's most probably a stupid question.

I want to calculate my GMP/COD which covers the years 1981/1982, 1982/83, 1983/84 and 1984/85.

I'm having trouble calculating the Earnings Factor. In a letter from NICO to me it says Earnings Factors are calculated as follows:-

Contracted out NICS x 100
Contracted out percentage

I've looked at example calculations on the NICO web site but presuming that Contracted out percentage is the same thing as Contracted out rebate the example calculations seem to be using different Contracted out percentage figures to the figures I copied from the NICO web site.

There is another point that I hope somebody can help me with concerning the Pension Service COD calculation.

I know that with the new Second State Pension the GMP and COD figures are the same. But I checked with the Pension Advisory Service and they confirmed that the Pension Service perform the SERPS COD calculation and that this calculation may produce a figure slightly more or less than the GMP figure produced by NICO which could mean a couple of pounds extra per week. However, all that it says in the 2005 a guide to State Pensions is 'for early leavers we perform a different calculation'. Does anybody know where I can find this calculation?

Any replies will be gratefully received. Thanks.

SnowMan

The contracted-out percentage in that calculation is the rate of national insurance paid at the contracted-out rate and not the rebate itself.

For 81/82, 82/83, 83/84, 84/85 the contracted-out percentages were respectively 5.25%, 6.25%, 6.85%, 6.85%.

For 81/82 for example the percentage of 5.25% is 7.75% less 2.5% where 7.75% is the contracted-in national insurance rate and 2.5% is the contracted-out rebate.

They changed what the employer had to record and supply to NICO from contracted-out contributions to contracted-out earnings hence the need for the conversion for earlier tax years to get everything into the same contracted-out earnings format (or "earnings factors") before the next part of the complicated calculation could be performed.

As an example if the contracted-out contribution for 81/82 was £200 then the contacted-out earnings (i.e. "earnings factor") are equal to £3,810 (= (200/5.25)x100)


To start to answer your other question, SERPS and GMP calculations differ for a number of different technical reasons which include a) SERPS being based on the average of the best 20 years revalued earnings whereas GMP is based on the average of all revalued years, b) different accrual rates for GMPS and SERPS following the scaling back of GMPS taking place before the scaling back of SERPS and c) different revaluation methods where GMPS resulted from contracted-out schemes.


The best practical advice I can give you is to just accept the figures are right. The calculations are incredibly complex.

Sixtiesman

Thanks a lot for that Snowman that's a big help.

But with the SERPS COD calculation I understand that it's only the same figures from the SERPS calculation for the four years that I was contracted out. I've done that calculation so I just wanted the format for the COD calculation.

SnowMan

I am presuming you were in a contracted-out company pension scheme (probably final salary) for this period. And did you leave that scheme at some point? If so what was the date of leaving and how was GMP revalued under the scheme rules on leaving and when do you reach SPA?

For the GMP calculation the Earnings Factors are revalued in line with s148 orders (broadly speaking average national average earnings NAE increases) from the relevant tax year up to the date of leaving the scheme. The resulting revalued earnings factors are then divided by the GMP accrual rate to give the GMP at leaving (the accrual rate roughly speaking is based on the accrual of a 25% pension over that part of your working lifetime 16-65 ish, that fell after 6/4/78 and is likely to be the same as teh accrual used in the SERPS calculation).

When you left the scheme the scheme would then have revalued the GMP between leaving and SPA. This revaluation would have been either limited rate (5% or NAE if less), fixed rate (8.5% for leaving dates before 6/4/88) or in line with NAE (typically public sector type schemes only used this method). The scheme rules would have determined which of these methods was used. For the SERPS calculations the revaluation is always NAE.

So the different revaluation over long periods can result in big percentage differences between GMP and SERPS

You should have a deferred benefit statement from your scheme which will show the GMP at leaving and resulting revaluation method.

Complicated I know. But you did ask!!!!!!!

Sixtiesman

Thank you Snowman that's really usefull - I'll go back and have another go.

I left U.K. in 1995 and my Pension (retirement) date was 3rd September 2007. I didn't get a deferred benefit statement but the revaluation rate was 18.5%.

I didn't find the SERPS pension calculation so difficult to do but what I thought before I began was that the total SERPS pension for the period that I was contracted out would roughly equal my GMP pension but there is a big difference 22.00 SERPS as opposed to 36.77 GMP.

In 2003 the COSR scheme that I was in went into wind-up and as I didn't know what a GMP or COD was I accepted a proposal to transfer into a money purchase scheme -thinking that I was at least getting some money out of a Pension Scheme that was going bust. I live in Thailand so almost everything was done by e mail and I think that I got well and truly stitched-up on the transfer value. Obviously the chickens came home to roost when I applied for my pension.So that will be the next thing I have to have a go at.

Thanks again for your help it's much appreciated.

Regards,
Sixtiesman

SnowMan

Not sure I quite get those dates but I think I can see the likely explanation.

If you were treated as having left the occupational scheme around 1985 (it is when you cease to be a contributing member that matters and that is what I mean throughout by date of leaving) and reached SPA in 2007 then we are looking at roughly 22 years of revaluation.

Now if the occupational scheme revalues GMPs at 8.5% per annum after leaving (I think you mean 8.5% not 18.5%?) then we are looking at a revaluation factor of around 6.018 (=1.085^22).

Now as mentioned SERPS revalues in line with NAE from leaving to SPA then the revaluation factor for NAE for the same period might be 3.274

This figure is based on the revaluation factor for the 22 years from 85/86 to 2007/2008 from this table of 227.4, and 1+227.4/100 = 3.274

http://www.watsonwyatt.com/europe/pubs/statistics/render2.asp?ID=14


So your GMP at SPA of 36.77 implies a GMP at leaving of about £6.11 (since 6.11 x 6.018 = 6.11)

And that would make your estimated SERPS about £20 (= 6.11 x 3.274) which isn’t far off the £22.

I've ignored the buyout in 2003 but I suspect this didn't affect the GMP COD calculation for example if the buy out was to a section 32 policy.


Note the logic behind the differing revaluations was that occupational schemes did not want to take on uncertain liabilities increasing with earnings so were allowed to increase GMP at a fixed rate representing an estimate of future earnings inflation which at the time was 8.5%.

However we moved into a lower inflation/interest rate economy in subsequent years so the 8.5% was a huge over-estimate of NAE.

Hence the divergence between SERPS and GMP.

The unfortunate side affect is that your state pension is reduced by this difference. The State would justify this by arguing that if actual NAE had exceeded 8.5% rather than the other way round they would have topped up your state pension not reduced it.


edit: I am guessing you have alraedy seen it but the main CA guide on calculating GMPS is in document CA14 at
http://www.hmrc.gov.uk/pdfs/nico/ca14.pdf

Sixtiesman

Thanks very much for all your help.Could I just ask a quick final questions and then I'll leave you in peace - I feel a bit guilty about taking up so much of your time.

I thought that the Pension Service used actual amounts to calculate SERPS i.e. The total earnings on which NICs have been payed between the Lower Earnings Level and the Upper Earnings Level but when they sent me the figures for the SERPS Calculation they referred to Earnings Factors. Does this mean that their calculation is based on NICs rather that actual P60 amounts?

Once again many thanks!

Sixtiesman

SnowMan

Sixtiesman wrote: »

Thanks very much for all your help.Could I just ask a quick final questions and then I'll leave you in peace - I feel a bit guilty about taking up so much of your time.

That’s snow problem. You’re very welcome.

For tax years up to 86/87 employers supplied HMRC with contracted-out contributions and nothing else, but from 87/88 the reported figure changed and employers thereafter supplied HMRC with contracted out earnings (i.e. earnings between the LEL and UEL on which NI was paid) rather than contracted out contributions. As a result HMRC had to do a calculation to work back from the contracted-out contributions to derive the NIable earnings between LEL and UEL for tax years up to 86/87. See page 134 of CA14 for an example of this.

Earnings Factor just means earnings between the LEL and UEL on which NI is paid, but because the pre 86/87 figures are derived by HMRC from the contacted-out contributions, whereas the post 87/88 figure is supplied direct to them by the employer, I think they decided to invent a fancy name for it.

Note P60 taxable earnings (between the LEL and UEL) are not the same as earnings between the LEL and UEL on which NI is paid. Most commonly this is because employee pension contributions are not taxable and so excluded from P60 earnings but are included within earnings on which NI is paid.

Sixtiesman

Sorry for being so thick but I can't quite understand.

I thought that you paid contributions on all pay between the LEL and UEL so when I started to calculate my SERPS I just took my gross Earnings from my P.60, after lowering them to UEL where appropriate, then I deducted the LEL and revalued the balance by the revaluation factors for 2006.

I was actually looking at the P.45s today and they did change their format in 1987 because after then they have a new item 'Earnings on which contributions have been paid' with figure below it. But the only COSR scheme that I have been a member of was the one in respect of my GMP ((1981 to 1984). So I don't understand why that figure isn't the same as the Surplus figure that I arrived at (as above) and why it's so low. I did try to get to the figure by playing around with the other figures on the P.60 but couldn't do it.

What would be the calculation method to use with Pre 1987 P.60s to find my Earnings figures?

Sorry if I'm being a nuisanse,

Sixtiesman

SnowMan

National insurance contributions would indeed be 5.25%, 6.25%, 6.85%, 6.85% of earnings between the LEL and UEL for the 4 tax years involved from 81/82 to 84/85 respectively.

To return to my earlier example I am assuming that employee contracted out CONTRIBUTIONS are showing on your P60 for 81/82 etc.

Now if the employee contracted out contributions showing on your P60 were (say) £200 for 81/82 then your earnings between the LEL and UEL (or Earnings Factor) would be £3,810 (= 200/0.0525). Adding back the LEL of £1,404 would mean you were earning £5,214.

You can then check your P60 to see if you were earning £5,214, if you weren’t then something has gone wrong in notifying the right figure to HMRC. Your P60 might show taxable earnings of (say) £5,058 a slightly different figure to the £5,214 the explanation of the difference being that you had paid (say) £156 ( = 5,214 - 5,058) of non-taxable pension contributions over the year.

If you were earning above the UEL then you would expect your Earnings Factor for 81/82 in the SERPS and GMP calculations should be £8,996 (10,400 UEL – 1,404 LEL). Obviously your taxable earnings on the 81/82 P60 would be a bigger figure than £10,400 because it is not restricted to the UEL. If you were earning above the UEL contracted out employees contributions for 81/82 would be the maximum figure £472.29 (= (10,400 - 1,404)*0.0525).

Sixtiesman

Hi Mr. Snowman,
I thought that I had become a Diploma standard Serps and NIC student under your excellent tutorship but I find I have to come crawling back as I find myself stumped.
I was Contracted-out three times and brought back into SERPS each time by CEP. The problem I have is getting to the correct NICs for each of those periods.
On the P.60 is the 'Total Contributions Payable by Employee" and 'Total Contributions at Contracted-out rate". I thought that as I was Contracted-back in the correct NICs to use in a calculation would be 'Total Contributions Payable by Employee' but it doesn't seem to work. What am I doing wrong?
It's made worse by the fact that there is an overlap between Contracted-back in and Contracted-out in the GMP period plus in the same period there was an underpayment in NICs followed by a large overpayment.
Hoping you can put me back on course,

Regards
Sixtiesman.