Rumours that the Department for Work and Pensions (DWP) is considering abolishing contracting out into final salary schemes would simplify the pensions system and create greater equality between defined benefit (DB) and defined contribution (DC) plans, says Hargreaves Lansdown.

However, the company warned that National Insurance Contributions would increase for seven million members of DB schemes and their employers – these workers currently enjoy a 1.6 per cent discount on the National Insurance they pay, and their employers are granted a 3.7 per cent discount. Should these discounts be removed, Hargreaves Lansdown said, final salary benefits could be cut back and in some cases, schemes could close.

In return for the additional National Insurance paid, scheme members could, however, receive a final salary pension backed by the government – the State Second Pension.

The government would benefit in the short-term from abolishing contracting out completely, with contracting out into both DB and DC schemes costing the government an estimated £9.5bn in National Insurance in 2009/10, according to HMRC. This, Hargreaves Lansdown said, is equivalent to ten per cent of the total annual National Insurance take. However, the government would then be responsible for paying out more state pension, and this burden would be spread over several decades.

Laith Khalaf, pensions analyst at the firm, said: “Abolishing contracting out for final salary schemes would undoubtedly cause teething problems in the short term. But the payoff is it could ultimately pave the way for a simpler and higher universal state pension for all.”

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