What is contracted out deduction on state pension and how to receive your full payout in 2022

The state pension is the cornerstone of all retirement income but despite diligently paying National Insurance for years, millions will fall short of receiving the full stipend.

The new “flat rate” state pension started to be paid in April 2016, sparking a flurry of voluntary payments from those who wanted to ensure they had paid enough into the system to qualify. Those approaching retirement rushed to secure the full amount, now around £180 a week.

However, complications mean that in reality the payouts are not “flat”, and many people receive less than the full amount. Just four in 10 people reaching the state pension age since the introduction of the new state pension receive the full rate, according to figures published by the Department for Work and Pensions.

Sir Steve Webb, of consultancy LCP, has written a report on state pension reductions and said the system had caused confusion for those reaching state pension age. “State pension statements and forecasts are full of abbreviations which can make little sense,” he said.

Convoluted, jargon-heavy documents have long befuddled the newly retired, with reports explaining the calculations packed full of unrecognizable terms. So how does it work and why might I not be receiving the full amount?

How do I receive the full state pension?

To qualify for the full amount you need to have made at least 35 years of qualifying National Insurance contributions or received credits for raising children or providing care. The amount you receive under the new state pension depends on your record of paying National Insurance contributions.

You will need at least 10 years in total on your NI record to receive any state pension. But in order to qualify for the full new state pension, which is currently £179.60 per week, you need a total of 35 qualifying years.

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However, some have completed the full 35 years and are still not entitled to the full rate.

What is contracting out deduction?

Millions of people have spent at least one year paying into a “contracted out” pension, which is meant to replace part of their state pension. This will affect the final amount they receive later on.

Anyone who was contracted out paid lower National Insurance contributions and therefore their state pension may be lower as a result.

You can check with your pension provider to see if you were contracted out at any point or you can check old payslips. If the NI contribution line has the letter “D” or “N” next to it that means you were contracted out. Whereas the letter “A” means you paid your contribution in full.

You are likely to have been contracted out if you worked in the public sector and were a member of one of the “defined benefit” pension schemes. This applies if you were the armed forces, the police forces, the NHS, teaching, the civil service, fire services or local councils.

The rules changed in April 2016 when contracting out ended and employed workers all paid the standard amount of NI.

Sir Steve said: “Although contracting out was finally abolished more than five years ago, its impact can still be seen in the pensions of millions of people in retirement and yet to retire.”

Members of “defined benefit” or final salary pensions could be contracted out from 1978. Eligibility was widened to include savers with “defined contribution” pensions in 1988.

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For those who were contracted out, the government offered rebates that were put in a separate pot and referred to as “protected rights”.

“Many people are unhappy when an amount is deducted from their state pension to reflect past contracting out but they may have forgotten (or be unaware) that they saved money on their NI bills by being contracted out,” the LCP report said.

However, it is important to remember that the reduced state pension was used elsewhere, Sir Steve said. “Contracting out via a salary-related pension was a deal. In simple terms, workers and employers benefited from a reduced rate of NI contributions.”

Did you have to choose to contract out?

Many people were automatically contracted out by their workplace pension and made no active decision to do this.

However, from 1988 to 2012, it was possible to contract out from personal pensions. In this case the worker benefited from a rebate of NI contributions which was paid into a personal pension and invested, according to LCP.

“Whether the pension at retirement generated by that money was higher or lower than the state pension given up depended on things like the investment performance of the pot and annuity rates at retirement,” the report said.

Most people in this position will have a deduction from their state pension which does not exactly match the private pension they built up in replacement and in some cases, the deduction will exceed the amount of private pension built up, LCP warned.

How much will be deducted?

State pension forecasts issued by the Department for Work and Pensions contain a “cope” figure, which stands for “contracted out pension equivalent.”

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This figure shows an estimate of how much the saver might have earned from having contracted out.

How can I reverse the pension cut?

Anyone who has been contracted out can keep working and paying NI, or receiving NI credits to top up their amount of qualifying years.

However, those who reach the state pension age before they have had a chance to rebuild their NI record can do very little to reverse the effect. They will not have enough time to pay the NI necessary to build themselves back up to the full new amount.

Many have spent thousands of pounds topping up their state pension when they reach state pension age but have had no benefit for it at all.

Shirley Nellthorpe, from Hampshire, paid £5,116 to HMRC in the lead-up to her 66th birthday in January 2021 to ensure she received the full state pension. However, it was only nine months after making the final payment last October that she was told it would not have a bearing on her state pension de ella. She was also told there was no guarantee she would get her money back.

ReaderService: Do you know what makes a good pension pot? Learn how to find your old pensions to boost your savings.

This article is kept updated with the latest information.

Has contracting out affected your state pension? Get in touch with Jessica Beard at [email protected]


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George Holan

George Holan is chief editor at Plainsmen Post and has articles published in many notable publications in the last decade.

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