SERPS and Contracting out

worn_out

I thought the idea of contracting out was that you 'could' get a better deal from your employer than the state.SERPS scheme.  What I didn't realise was that when you retire the DWP thereafter revalue your pension by CPI each year and if your contracted out  pension is higher you don't get any increase until it has fallen to the same value as you would have received had you stayed in the state SERPS scheme..

To elaborate, contracting out had 2 schemes, one from 1978-1987 when revaluation was at a fixed %'age provided by the DWP. This usually gave you a higher pension because these %'ages were as high as 8.5%..much higher than average wage increases. The 'rub' however was that you'd never get an annual increase once this started to be paid. The reason, as exlained above, is that each year the DWP basically works out what you 'would have' received had you not contracted out..which is a lower figure..so until such time as they are the same you never get an annual  increase.

The 2nd part of the contracting out scheme from 1988 to 1997 was less generous as average wages was used rather than a %'age.., the same as the state scheme..so by the time you get to 65 this is the same £ amount as you would have received had you not contracted out..But the rub here is there is an inflation  cap if you contracted out, at 3%...whereas the DWP inflate their figure by CPI...so it should give you a bit more cash with your state pension. It doesn't... The reason is the DWP look at your 1978-87 figures and see that you are receiving much more than the state figure would have been and so combine this with the 1988-97 figure so you don't get CPI, you get the capped 3%(max). on just the 88-97part.

if you live long enough ..like until 100+ , you might eventually get an annual increase equivalent to inflation, but most people will never get a full inflation increase on this element of their pensions.. That would mean your 'contracted out' pension is exactly the same as you would have received if you had stayed in SERPS (as was)..

I wondered why the 3% cap was introduced for the 88-97 element, because in essence this amount is exactly the same amount as the DWP calculate you'd get under SERPS..and that revalues at the full CPIeach year.. It's only become an 'issue' because inflation is much higher than 3%. and likely to remain so for 2 or 3 years.

zagfles

You seem to have misunderstood this.

You must have reached SPA (state pension age) before April 2016 so on the old state pension. 

So your state pension consists of BSP + SERPS/S2P - COD + maybe GP 

(BSP is basic state pension, COD is contracted out deduction, GP is graduated pension if you worked pre 1975).

It looks like you left a contracted out scheme before SPA.

When you left, your occupation pension would have been split into the "GMP" and "excess". The GMP is the guaranteed minimum pension which replaces SERPS/S2P. The "excess" is whatever your occupational pension pays above the GMP. So you do benefit from the "excess" whatever, as this is whatever your occupational scheme pays better than SERPS. The excess is usually revalued using statutory rules (usually inflation capped at 5%)

The GMP would then have been revalued by either a fixed amount, eg the 8.5% you mention (it depends on the date of leaving), or using average earnings increases. The scheme can decide which. Generally private sector schemes used fixed, and public sector earnings increases. See https://www.barnett-waddingham.co.uk/comment-insight/blog/revaluation-for-early-leavers/

There's no difference whatsoever between the pre and post 1988 GMP at this stage. It all revalues the same.

The COD equals the GMP. So the COD is revalued at the same rate as the GMP.

But SERPS is only revalued with earnings.

That means that if you have a high revaluation rate, eg 8.5%, you can end up in the situation at SPA where COD is much greater than SERPS. In this situation, your BSP is not reduced, COD can only reduce SERPS.

But once state pension is in payment, SERPS increases with CPI each year. The GMP paid by the scheme is increased for 1988-1997 service by CPI capped at 3%. 1978-88 service is not increased at all.

But the COD increases the same as the GMP. Therefore, as the years go by in retirement, SERPS will generally increase by more than the COD/GMP. So if you started off at SPA with a COD much greater than SERPS, as the years go by eventually SERPS will catch up with the COD and you'll start getting paid some SERPS in addition to the BSP.

The stupidly complicated way it's done means you're better off if you had a high fixed revaluation rate for deferred GMP, because you benefit from the high GMP increases without getting it deducted in full from your state pension, as COD can't reduce the BSP, until the time when SERPS catches up with the COD/GMP.

Simples. Really not!

hyubh

zagfles said:

Simples. Really not!

Maybe so, but that was great explanation!

worn_out

zagfles said:

You seem to have misunderstood this.

You must have reached SPA (state pension age) before April 2016 so on the old state pension. 

So your state pension consists of BSP + SERPS/S2P - COD + maybe GP 

(BSP is basic state pension, COD is contracted out deduction, GP is graduated pension if you worked pre 1975).

It looks like you left a contracted out scheme before SPA.

When you left, your occupation pension would have been split into the "GMP" and "excess". The GMP is the guaranteed minimum pension which replaces SERPS/S2P. The "excess" is whatever your occupational pension pays above the GMP. So you do benefit from the "excess" whatever, as this is whatever your occupational scheme pays better than SERPS. The excess is usually revalued using statutory rules (usually inflation capped at 5%)

The GMP would then have been revalued by either a fixed amount, eg the 8.5% you mention (it depends on the date of leaving), or using average earnings increases. The scheme can decide which. Generally private sector schemes used fixed, and public sector earnings increases. See https://www.barnett-waddingham.co.uk/comment-insight/blog/revaluation-for-early-leavers/

There's no difference whatsoever between the pre and post 1988 GMP at this stage. It all revalues the same.

The COD equals the GMP. So the COD is revalued at the same rate as the GMP.

But SERPS is only revalued with earnings.

That means that if you have a high revaluation rate, eg 8.5%, you can end up in the situation at SPA where COD is much greater than SERPS. In this situation, your BSP is not reduced, COD can only reduce SERPS.

But once state pension is in payment, SERPS increases with CPI each year. The GMP paid by the scheme is increased for 1988-1997 service by CPI capped at 3%. 1978-88 service is not increased at all.

But the COD increases the same as the GMP. Therefore, as the years go by in retirement, SERPS will generally increase by more than the COD/GMP. So if you started off at SPA with a COD much greater than SERPS, as the years go by eventually SERPS will catch up with the COD and you'll start getting paid some SERPS in addition to the BSP.

The stupidly complicated way it's done means you're better off if you had a high fixed revaluation rate for deferred GMP, because you benefit from the high GMP increases without getting it deducted in full from your state pension, as COD can't reduce the BSP, until the time when SERPS catches up with the COD/GMP.

Simples. Really not!

Thanks for taking the time to put that reply together..much appreciated. You're correct SERPS is catching up with COD but it will never actually achieve this in my lifetime. I accept I'm benefiting from from the higher GMP despite the fact it's never going to increase.

Do you know why the post '88 is capped at 3%...I mean it's my former employer who's paying this, not the State..in fact the state (DWP) are happy to increase this by CPI ..so what's the reason ? My last point is again the difference between pre and post '88 ..the formula is different but  they are banded under one header the post '88 which is higher than the COD amount but because the pre'88 GMP is much higher then 3% is all we get whatever the rate of inflation is..

hyubh

worn_out said:

I accept I'm benefiting from from the higher GMP despite the fact it's never going to increase.

Do you know why the post '88 is capped at 3%...I mean it's my former employer who's paying this, not the State..in fact the state (DWP) are happy to increase this by CPI ..so what's the reason ? 

A scheme is free to pay whatever increases it wants, if it meets statutory minimums. In the case of pre-88 GMP this is nil, in the case of post-88 GMP it's the increase on SERPS and public sector pensions capped to 3%, in the case of any pre-97 excess it's nil again.

My last point is again the difference between pre and post '88 ..the formula is different but  they are banded under one header the post '88 which is higher than the COD amount but because the pre'88 GMP is much higher then 3% is all we get whatever the rate of inflation is..

So I think you're saying (correct me if I'm wrong!): since the COD isn't kept in separate pre- and post-88 tranches, the (higher) revaluation on the pre-88 GMP has eaten into what would have been the potential above 3% increase on post-88 GMP...?

xylophone

Do you know why the post '88 is capped at 3%..

See

https://forums.moneysavingexpert.com/discussion/comment/80126301/#Comment_80126301

xylophone

And you might be interested in

https://researchbriefings.files.parliament.uk/documents/SN02674/SN02674.pdf

zagfles

worn_out said:

zagfles said:

You seem to have misunderstood this.

You must have reached SPA (state pension age) before April 2016 so on the old state pension. 

So your state pension consists of BSP + SERPS/S2P - COD + maybe GP 

(BSP is basic state pension, COD is contracted out deduction, GP is graduated pension if you worked pre 1975).

It looks like you left a contracted out scheme before SPA.

When you left, your occupation pension would have been split into the "GMP" and "excess". The GMP is the guaranteed minimum pension which replaces SERPS/S2P. The "excess" is whatever your occupational pension pays above the GMP. So you do benefit from the "excess" whatever, as this is whatever your occupational scheme pays better than SERPS. The excess is usually revalued using statutory rules (usually inflation capped at 5%)

The GMP would then have been revalued by either a fixed amount, eg the 8.5% you mention (it depends on the date of leaving), or using average earnings increases. The scheme can decide which. Generally private sector schemes used fixed, and public sector earnings increases. See https://www.barnett-waddingham.co.uk/comment-insight/blog/revaluation-for-early-leavers/

There's no difference whatsoever between the pre and post 1988 GMP at this stage. It all revalues the same.

The COD equals the GMP. So the COD is revalued at the same rate as the GMP.

But SERPS is only revalued with earnings.

That means that if you have a high revaluation rate, eg 8.5%, you can end up in the situation at SPA where COD is much greater than SERPS. In this situation, your BSP is not reduced, COD can only reduce SERPS.

But once state pension is in payment, SERPS increases with CPI each year. The GMP paid by the scheme is increased for 1988-1997 service by CPI capped at 3%. 1978-88 service is not increased at all.

But the COD increases the same as the GMP. Therefore, as the years go by in retirement, SERPS will generally increase by more than the COD/GMP. So if you started off at SPA with a COD much greater than SERPS, as the years go by eventually SERPS will catch up with the COD and you'll start getting paid some SERPS in addition to the BSP.

The stupidly complicated way it's done means you're better off if you had a high fixed revaluation rate for deferred GMP, because you benefit from the high GMP increases without getting it deducted in full from your state pension, as COD can't reduce the BSP, until the time when SERPS catches up with the COD/GMP.

Simples. Really not!

Thanks for taking the time to put that reply together..much appreciated. You're correct SERPS is catching up with COD but it will never actually achieve this in my lifetime. I accept I'm benefiting from from the higher GMP despite the fact it's never going to increase.

Do you know why the post '88 is capped at 3%...I mean it's my former employer who's paying this, not the State..in fact the state (DWP) are happy to increase this by CPI ..so what's the reason ? My last point is again the difference between pre and post '88 ..the formula is different but  they are banded under one header the post '88 which is higher than the COD amount but because the pre'88 GMP is much higher then 3% is all we get whatever the rate of inflation is..

It's just the split between what the state is responsible for and what the scheme is. Remember that schemes had no statutory obligation to increase any pensions in payment accrued pre 97, other than the post 88 GMP. Many did, but it wasn't required by law. Over the years/decades, increasing obligations were placed on schemes, eg increases in payment, paying into the lifeboat, funding requirements etc, some would say these were a major factor in the massive decline in DB schemes in the private sector.

Anyway - if you start by thinking about how it'd work for someone who stayed in the DB scheme right up to SPA and retired then. Their SERPS, GMP and COD would all be the same at SPA. So in the first year of retirement the scheme would pay the GMP and they'd just get the BSP from the state, no SERPS. 

But after a year, say CPI was 3%. The scheme would increase the post 88 GMP by 3%, and not increase the pre 88 GMP at all. But SERPS would increase by 3% on the whole lot. So after a year, they'd effectively get the pre 88 GMP inflation uplift paid by the state, as SERPS - COD would now be 3% of the pre 88 GMP. So it wouldn't make any difference to the pensioner, they get the same overall amount as if the whole GMP was index linked, just that some of it now comes from the state instead of the scheme. 

That was how the system was supposed to work - by contracting out you should get fully index linked equivalent of SERPS, partly inflation protected by the state and partly by the scheme.

But in your situation where the GMP/COD starts off much higher than SERPS, there's an anomaly in the rules that COD can't reduce the BSP, only SERPS. If it could, then you'd be in the exact same situation as above. The GMP paid by the scheme minus the reduction in your BSP would equal the SERPS you would have been paid if contracted in. And your GMP would be fully inflation protected, partly by the state.

But as COD can't reduce the BSP, this anomaly gains you COD-SERPS every year, but the advantage reduces every year as SERPS catches up with COD. So it looks like you're missing out on inflation increases, but in reality it's just what you gain from this anomaly reduces every year till it's gone, at which point you'll be fully inflation protected on the GMP!

worn_out

hyubh said:

worn_out said:

I accept I'm benefiting from from the higher GMP despite the fact it's never going to increase.

Do you know why the post '88 is capped at 3%...I mean it's my former employer who's paying this, not the State..in fact the state (DWP) are happy to increase this by CPI ..so what's the reason ? 

A scheme is free to pay whatever increases it wants, if it meets statutory minimums. In the case of pre-88 GMP this is nil, in the case of post-88 GMP it's the increase on SERPS and public sector pensions capped to 3%, in the case of any pre-97 excess it's nil again.

My last point is again the difference between pre and post '88 ..the formula is different but  they are banded under one header the post '88 which is higher than the COD amount but because the pre'88 GMP is much higher then 3% is all we get whatever the rate of inflation is..

So I think you're saying (correct me if I'm wrong!): since the COD isn't kept in separate pre- and post-88 tranches, the (higher) revaluation on the pre-88 GMP has eaten into what would have been the potential above 3% increase on post-88 GMP...?

that's correct. I know it's a futile argument but  the Pension Service write me every year. with my new state pension and then the difference between my 'pre '97 add'l state pension versus my COD,.. It's not been an 'issue' while CPI was below 3% because my post '88 COD was always exactly the same (within a few pence)  for the past 7 years...however now my post '88 Add'l state pension is £3.07 higher. ..

worn_out

Ok thank you, I've got my head round this now having had it put into perspective..I was lucky in the sense I left my company in 1987 and so my GMP got 27 years at 8.5%..I took advice and did a Sec32 with Norwich Union because it 'couldn't lose'...Of course NU couldn't beat 8.5%pa  but it didn't cost me anything. What I'd missed was the annual SERPS adjustment with my state pension and that the 'rules' seemed to be based on continuous employment...The change in 1988 from a fixed % to the same method as SERPS makes sense tbh .although back in the day the Govt promoted this 'contracting out' of SERPS saying you'd likely be better off doing it. but the reality is that you end up with exactly the same as you would have received under the old Serps scheme..The 'winners' were people who left their job before 1988 and got the fixed % guarantee so I'm surprised the GMP was transferable to your new employer..or maybe it was, I can't remember ?

Thank you so much for your time, I really appreciate it..

hyubh

worn_out said:

The change in 1988 from a fixed % to the same method as SERPS

That's not quite correct. All through there was the choice of 'fixed' or 'full rate' GMP revaluation (and until 1997, so-called 'limited rate', which was full rate capped to 5% with potentially a 'limited rate premium' due from the scheme to the state). Full rate revaluation matches the revaluation of SERPS. The fixed rate percentage has been reviewed from time to time, and the general trajectory has been downwards (https://adviser.royallondon.com/technical-central/rates-and-factors/fixed-rate-gmp-revaluation/). When it changes however, it only affects people leaving their occupational scheme going forward. And on an individual level, if someone (like yourself) already ready had a GMP in deferment, then the old rate didn't retrospectively change.

back in the day the Govt promoted this 'contracting out' of SERPS saying you'd likely be better off doing it. but the reality is that you end up with exactly the same as you would have received under the old Serps scheme

GMP was not supposed to be better than SERPS in principle, hence the name ('guaranteed minimum'). It was rather to ensure you didn't lose out by contracting out, which would typically involve additional, scheme-specific benefits (in particular an 'excess' pension if DB, or in the case of post-88 personal pensions, to invest your NI rebate as you choose, broadly speaking).