Introduction to State Second Pension S2P
The Child Support, Pensions and Social Security Act 2000 included a number of changes to SERPS, which was then replaced by the state second pension (S2P) from the tax year 2002/2003 onwards. Both S2P and SERPS are commonly referred to as ‘additional state pension’.
Background to S2P
The previous Government’s objectives for pension provision were initially set out in the 1998 Green Paper ‘A new contract for Welfare: Partnership in Pensions’ and followed by the White Paper ‘Security in retirement; towards a new pension system’.
The objectives were to provide security for those who could not provide for themselves and to make it easier for people who could save, to do so.
To support the objectives, the then Government felt, among other things, that State provision in retirement should be concentrated on people on lower earnings and that funded pensions should be made more attractive for those on moderate earnings. Although state pension policy has moved on considerably since the late 1990s, the aim of focussing state benefits on the lower paid has remained a key driver.
To achieve the 1998 objectives, the S2P was designed to offer better provision to lower earners, carers and some long term disabled people with broken work records. In addition low cost, flexible stakeholder pensions help moderate earners who did not have access to an employer’s occupational pension scheme.
Following a Green Paper on the reform of state pension benefits, the current Government announced in the March 2012 Budget that it intended to introduce an increased single-tier pension (expected to be between £140 and £150 a week) for ‘new pensioners’. This pension will replace any entitlement for basic state and additional state pension benefits. Further details of how this will work, including its likely implementation date are due to be set out in a White Paper to be issued in the Spring of 2012.This will address the treatment of those individuals whose accrued state additional pension entitlement would result in total state benefits exceeding the new flat rate amount.
Eligibility for S2P benefits
The following individuals are currently eligible for S2P benefits:
· Employees with earnings at or above the Lower Earnings Limit (i.e. £107 per week in 2012/13)
· Credits for parents and carers, referred to as ‘Carer’s Credit’, introduced from April 2010. These are available for individuals who meet certain criteria:
- In receipt of Child Benefit for a child under 12 (even if another individual suffers the Child Benefit Income Tax Charge)
- a registered foster carer
- caring for one or more sick or disabled people for at least 20 hours a week. Those cared for must be in receipt of one or more the following benefits:
§ Disability Living Allowance care component at the middle or highest rate
§ Attendance Allowance at any rate
§ Constant Attendance Allowance at any rate
In some cases Carer’s Credits are awarded automatically, where in receipt of:
- Carer’s Allowance
- Child Benefit, for a child under 12
- Income Support and regularly and substantially engaged in caring
- Or are a foster carer.
· Disabled individuals who are entitled to Incapacity Benefit or Severe Disablement Allowance and the long-term sick and disabled who qualify for Employment and Support Allowance
· Individuals with long term illness or disabilities who qualify for Employment and Support Allowance,
From 2010/11 the arrangements which enable certain parents, carers and people who are long-term sick or disabled to build up S2P were made less restrictive. Previously, people were only credited into S2P for each complete tax year during which they satisfy the relevant condition. This meant that a person who moved off Incapacity Benefit into work part way through the tax year would lose a year’s worth of S2P accrual unless his earnings for the part-year were at or above the minimum annual threshold for that year (ie £4,940 in 2009/10). The Pensions Act 2007 replaced these arrangements so that from 6 April 2010 onwards, people will qualify for credits on a weekly basis and will be able to build up S2P by combining earnings and credits or by combining credits for different qualifying conditions during the same tax year.
One of the qualifying conditions for these ‘earnings factor credits’ is receipt of long-term Incapacity Benefit. Long-term Incapacity Benefit is payable after 52 weeks’ incapacity and is reinstated after a break in claim if the period of incapacity is treated as continuous under linking rules. People with underlying entitlement (ie. people who are providing evidence of incapacity but who do not receive benefit because they do not meet the contribution conditions or they receive payments from a pension scheme) are also covered. The Social Security (State Pension and National Insurance Credits) Regulations 2009 SI 2009/2206 insert a new provision in the The Additional Pension and Social Security (Home Responsibilities) (Amendment) Regulations 2001(SI 2001/1323) to extend the 2010 S2P crediting arrangements to people claiming Employment and Support Allowance (ESA) on broadly the same terms. (ESA replaced Incapacity Benefit and Income Support for people unable to work due to sickness for new claims from October 2008).
Under these provisions, people will start to build up weekly S2P credits once they have been in receipt of ESA (or have had underlying entitlement) for 52 weeks, whether consecutive or linked. This mirrors the provision for those entitled to long-term Incapacity Benefit. In addition, people will be credited into S2P for each week in which they are eligible for the ESA ‘support component’. The support component normally becomes payable after 13 weeks and applies to people who are assessed as belonging to the support group – ie those with more limiting conditions who are not required to engage in work-related activity. The new regulation also provided for people who qualify for ESA immediately following a period of entitlement to Statutory Sick Pay to qualify for credits after 13 weeks of ESA entitlement. This provision is limited to older workers who, without this provision, could have lost out in comparison to the position under Incapacity Benefit. Younger workers are expected to have any S2P shortfall made up through uprating the basic state pension in line with earnings.
Benefits provided by S2P
It was intended originally that S2P would be introduced in two stages.
Initially it was to be earnings related, similar to SERPS, but with three different rates of accrual. Nobody would be worse off under S2P compared with SERPS, while low earners or certain non-earners would be considerably better off. The idea at the launch of S2P was that once stakeholder pensions had become established, S2P would move to a fully flat rate scheme. The failure of stakeholder pensions seemed at one time to suggest that the idea of stage two had been abandoned. However, the concept was revived by the Pensions Commission (Turner Commission).
It had been envisaged that S2P should be amended to provide a totally flat rate weekly accrual from around 2031/32. However, with the Government’s announcement in the 2012 Budget of an increased single-tier flat rate state pension, which would incorporate any state additional pension entitlement, it seems that S2P will cease to exist well before then.
There have been a number of changes to how S2P benefits accrue. These differing accrual bases are set out in the subsections below.
From April 2002 to April 2010
Prior to 6 April 2010 S2P accrued at three different rates according to an individual’s earnings in accordance with the following table. It should be noted that where eligible individuals had earnings below the Low Earnings Threshold they were deemed to have earnings at that level for S2P accrual purposes.
|Band (2009/10)||Earnings (2009/10)||Accrual Rate (2009/10)|
|1||Lower Earnings Limit (LEL) of £4,940 to Low Earnings Threshold (LET) of £13,900||40%|
|2||Low Earnings Threshold (LET) of £13,900 to High Earnings Threshold (HET) of £31,800||10%|
|3||High Earnings Threshold (HET) £31,800 to the Upper Accrual Point (UAP) of £40,040*||20%|
The Lower Earnings Limit is the minimum level of earnings at which an employee will qualify for S2P.
The Low Earnings Threshold (LET) provides the threshold between Band 1 and Band 2 accrual. It was originally set as £9,500 in terms of the 1999/2000 tax year. Increases are in line with the change in national average earnings (NAE) from 1st October to 30th September ending in the previous tax year. So, when S2P was introduced in April 2002 the base LET of £9,500 was increased by the change in NAE from October 1998 to 30th September 2001 and rounded to the nearest £100. Subsequent increases are made annually by the Secretary of State under section 148A of the Social Security Administration Act 1992.
The High Earnings Threshold sets the crossover point between Bands 2 and 3. It is determined as the amount of the LET plus twice the Band 1 earnings, with appropriate rounding. This was abolished from 6 April 2010 when Bands 2 and 3 were merged for S2P accrual purposes (see below).
The Upper Accrual Point is the upper level of earnings on which an employee’s S2P entitlement is based. For tax year 2009/10 and subsequent tax years the Upper Accrual Point is fixed at £770 per week (£40,040 per year).
* Prior to tax year 2009/10 S2P had accrued on earnings up to the Upper Earnings Limit (UEL). As full rate employee NI contributions are still paid up to the Upper Earnings Limit (£42,484 in 2012/13), and the Upper Accrual Point will remain fixed at its current £40,040, there is a band of earnings on which full (contracted in) NI contributions are paid by both employee and employer but where there is no S2P accrual (or contracting out rebate). The size of this band has and will be shrinking because the UEL is set equal to the higher rate threshold, which was £43,875 in 2009/10 and 2010/11, fell to £42,475 for 2011/12 and 2012/13 and should drop again to £41,450 in 2013/14, in line with the 2012 Budget announcement of that year’s higher rate threshold.
Each tax year an individual’s earnings are assessed for S2P purposes.
For example, an individual with earnings of £44,000 in tax year 2009/10 would have had the following levels of earnings in the three bands:
Band 1 earnings – (£13,900 – £4,940) = £8,960
Band 2 earnings – (£31,800 – £13,900) = £17,900
Band 3 earnings – (£40,040 – £31,800) = £8,240
The earnings in each tax year are revalued to SPA in line with Orders made under s.148 of the Social Security Administration Act 1992. These increases are broadly in line with the changes in Average Weekly Earnings (formerly National Average Earnings). In recent times this has meant year-on-year increases below the rate of both CPI and RPI inflation. For example, the April 2012 increase was 1.8%, whereas the corresponding CPI figure was 5.2% and RPI, 5.6%.
When the member reaches SPA their revalued earnings in each band will be determined and their entitlement calculated as follows:
The number of years in the individual’s working life since April 1978 will need to be assessed (Section 44(7) of the Social Security Contributions and Benefits Act 1992). For S2P the notional period of accrual is the total number of years between 1978/79 (or the tax year in which the individual reached 16, if this is later) and the tax year ending before the one in which they reach State Pension age. For example, a man born in September 1952 would reach their SPA in September 2017, so the accrual period would be between 1978/79 and 2016/17, ie 38 years.
The individual’s revalued earnings in each band at SPA are then multiplied by the accrual rate applicable to each band and divided by the number of years in the individual’s working life.
For example, if the individual on reaching SPA, had a 40 year accrual period for S2P and had revalued earnings in each of the three bands as follows
Band 1 – £60,000
Band 2 – £120,000
Band 3 – £75,000
The S2P pension would be:
|£60,000 x 40% ¸ 40||=||£600|
|£120,000 x 10% ¸ 40||=||£300|
|£75,000 x 20% ¸ 40||=||£375|
The £1,275 equates to a weekly pension of £24.52, which will be added to the individual’s other state pension benefits.
From 6 April 2010
From 6 April 2010 Bands 2 and 3 of S2P accrual were merged with a 10% accrual applying on earnings between the LET and the Upper Accrual Point. The revised S2P accrual basis is as follows:
|1||Lower Earnings Limit (LEL) to Low Earnings Threshold (LET)||40%|
|2||Low Earnings Threshold (LET) to Upper Accrual Point||10%|
From 6 April 2012
From 2012/13 the Band 1 earnings related accrual is replaced with a weekly flat rate accrual. The actual amount of the flat rate accrual is set out in the Pensions Act 2007 as being initially £1.40 per week but it is to be uprated between 1 October 2004 and the 30 September in the tax year preceding the introduction of the flat rate accrual in line with the general level of earnings. The Social Security Pensions (Flat Rate Accrual Amount) Order 2012 – SI 2012 /189 sets the amount of the flat rate accrual applicable in 2012/13 as £88.40 (£1.70 per week). Had the figure been RPI-linked, it would have been £1.77 a week, again underlying the sub-inflation earnings growth of recent years.
The 10% accrual in respect of Band 2 will continue to apply but the maximum accrual within this band will reduce each year after 2010/11. This is because the Low Earnings Threshold will increase each year in line with earnings while the Upper Accrual Point is fixed at its 2009/10 level of £40,040.
The revised S2P accrual for 2012/13 onwards is:
|Earnings||S2P Accrual Basis|
|£5,564 (Lower Earnings Limit) – £14,700 (Low Earnings Threshold)||Flat rate of £88.40 for the tax year|
|£14,700 – £40,040 (Upper Accrual Point)||10% of band earnings accrued over working life|
From 2031/32 (in theory)
The original DWP expectation was that by around 2031/32 the Low Earnings threshold would have caught up with the Upper Accrual point (which is fixed at its 2009/10 level of £40,040). At that stage S2P would have become a totally flat rate accrual scheme.
However, with the Government’s announcement in the 2012 Budget of an increased single-tier flat rate state pension, which would incorporate any state additional pension entitlement, it seems that S2P will cease to exist well before then. In any event the 2031/32 target date was looking hopeless optimistic, as it would have required earnings growth of over 5.4% a year for the next 19 years for the LET to surpass the UAP.
Increases to S2P in Payment
Once in payment the individual’s S2P pension will be increased each April in line with the increase in prices over the 12 months to the preceding September. For increases up to and including that made in April 2010 the RPI was used as the measure for price inflation. However, for increases from April 2011 the CPI is now used for this purpose.
In-heritability of S2P
From 6 April 2010, a widow, widower or surviving civil partner may be able to inherit up to half of their late husband, wife or civil partner’s S2P benefit, provided they have not remarried or formed a new civil partnership before they reach State Pension Age.
If the deceased spouse or civil partner was contracted out, the inherited S2P may be reduced to reflect this.
Where an individual is in receipt of inherited additional state pension benefits the aggregate maximum additional state pension (inherited plus their own) he/she may receive is capped (£161.94 a week in tax year 2012/13).
Contracting out of S2P
Instead of receiving the S2P benefit, currently, an individual can be contracted out by being a member of a suitable defined benefit occupational scheme. That scheme will then provide benefits in place of S2P, although in some cases, as noted below, the National Insurance fund will also provide a top up pension at State Pension Age.
Prior to 6 April 2012 an individual could also be contracted out by means of a suitable defined contribution occupational scheme or personal pension/stakeholder scheme. However, contracting out under such schemes was abolished from 6 April 2012 by the Pensions Act 2007.
When a final salary scheme (COSR) is used to contract out of SERPS the scheme must pass a Reference Scheme benefit test. (This is a general benefits level test which must be passed by 90% of scheme members). A flat rebate is given in respect of each contracted out member by way of reduced employee and employer Class 1 National Insurance Contributions.
For tax years prior to 2012/13 an age related rebate of National Insurance Contributions was determined for each member. This was paid in two parts. A flat rate rebate of employee and employer National Insurance Contributions was given by way of a reduction in the National Insurance Contributions. After the end of the tax year HMRC NICO paid the balance of the rebate due, depending on the age of the individual, direct to the scheme.
It must be noted that from April 2002 the rebates for both members of COSR and COMP schemes continued to be calculated in the same way as under SERPS. The rebates did not make allowance for the enhanced benefits offered under S2P for lower earners (i.e. for anyone earning up to the Band 2 Threshold), and therefore to ensure that such individuals were not advised to contract back in to S2P, a S2P top up pension will also bepaid. The top up pension is determined as the difference between what the individual would have received under S2P when compared to SERPS, assuming in both cases that the member had not contracted out.
So in effect, contracting out for some was a partial opt out. The top up pension was introduced to avoid existing schemes having to make extensive changes and to remove the prospect of low and middle band earners opting out of the schemes in favour of S2P.
Personal and stakeholder pension schemes
For tax years prior to 2012/13 contracting out via a personal or stakeholder pension scheme (other than an Occupational Stakeholder Scheme) involved the complete replacement of the revised State benefit except for those earning below the Low Earnings Threshold (LET – £14,400 for the 2011/12 tax year). Note that the rebates were based on the individual’s actual earnings.
For all those earning at or above the LET the rebates reflected the benefit being given up under S2P. For those earning less than LET but above LEL the rebate was not sufficient compensation. This was because the S2P benefit being given up was based on the LET rather than their lower level of actual earnings. The additional amount that would have been provided by S2P will be paid as a top up pension at State Pension Age.
The top up pension will be calculated as the difference between the full S2P benefit (i.e. based on the LET) less the notional S2P benefit (based on actual earnings).
Contracted out rebates from April 2012
Every five years the Secretary of State for Social Security must lay before Parliament a report by the Government Actuary on the contracted out rebates for contracted out salary related (COSR) schemes, contracted out money purchase (COMP) schemes and appropriate personal pension (APP) schemes. For the quinquennium commencing 6 April 2012 the main report only covered the rebates for contracted out DB occupational schemes as contracting out on a money purchase basis was abolished with effect from that date. This must be accompanied by the Secretary of State’s own report, in light of the Government Actuary report, on the contracted out rebates to apply for the next five years, and the necessary draft statutory instruments to implement those new rebates. The reports and drafts must be laid in time for the new rebates to be approved by parliament one year prior to implementation.
The following statutory instrument was made on 31 March 2011 and came into force on 6 April 2012.
From 6 April 2012 the COSR scheme rebate was reduced from 5.3% of upper band earnings (UBE – earnings between the lower earnings limit and the upper accrual point) to 4.8% of UBE. The employer’s share of the rebate was reduced, from 3.7% to 3.4%, with the employee’s share of the rebate falling from 1.6%. to 1.4% of UBE.
Band earnings figures
|Tax Year||Band||Earnings||Accrual Rate|
|2002/03||123||£3,900 to £10,800£10,800 to £24,600£24,600 to £30,420||40%10%20%|
|2003/04||123||£4,004 to £11,200£11,200 to £25,600£25,600 to £30,940||40%10%20%|
|2004/05||123||£4,108 to £11,600£11,600 to £26,600£26,600 to £31,720||40%10%20%|
|2005/06||123||£4,264 to £12,100£12,100 to £27,800£27,800 to £32,760
|2006/07||123||£4,368 to £12,500£12,500 to £28,800£28,800 to £33,540||40%10%20%|
|2007/08||123||£4,524 to £13,000£13,000 to £30,000£30,000 to £34,840||40%10%20%|
|£4,680 to £13,500£13,500 to £31,100£31,100 to £40,040||40%10%20%
|2009/10||123||£4,940 to £13,900£13,900 to £31,800£31,800 to £40,040||40%10%20%|
|2010/11||12||£5,044 to £14,100£14,100 to £40,040||40%10%|
|2011/12||12||£5,304 to £14,400£14,400 to £40,040||40%10%|
|2012/13||12||£5,564 to £14,700£14,700 to £40,040||Flat rate £88.40 pa10%|