NIM02281 | Class 1 NICs: payment for leaving a Defined Benefit Pension Scheme (DBPS) or for giving up a right in such a scheme

Sections 3(1)(a) and 6(1) Social Security Contributions and Benefits Act 1992

Paragraph 2(a) of Part 6 of Schedule 3 to the Social Security (Contributions)Regulations 2001

One way in which an employer can provide retirement benefits for their employees is by setting up an occupational pension scheme. Broadly, there are two types of such schemes:

Typically, a Defined Benefit Scheme (DBS) pays a pension that is based on the employee’s length of service and the amount of their final salary. In a Defined Contribution Scheme (DCS), the amount of pension is based on theamount contributed by the employer and/or employee plus the investment growth of thosecontributions.

Because the cost of providing a pension via a DBS is met by the employer, over the past few years, such schemes have become increasingly expensive. This is especially so as an employer is responsible for making good any deficit in the funding of the pensions.

As a result, many employers are closing – either entirely or solely to new members- their DBS in favour of a DCS. In addition, in order to encourage members (whether current or former employees) of the DBS some employers are offering such members a cash payment. Employers (or former employers) may offer a:

• defined benefit scheme (DBS; also known as a final salary-related pension scheme); and

• defined contribution scheme (DCS; also known as a money purchase scheme).

However it is referred to, such a payment is:

• to transfer the value of their benefits in the DBS into either a DCS scheme or some other registered pension arrangement of the member’s choice; or

• to give up some right under the DBS whilst remaining a member of it – for instance, giving up the right to future increases in the rate of pension payable by the DBS.

But where the employer (or former employer) makes payment direct to an alternative registered pension scheme (see NIM02715), the employer (or former employer) may:

• refer to such cash payments to in a variety of ways: cash inducement; one- off cash payment; ex-gratia payment; immediate cash sum; (additional) (cash) compensation payment; additional payment; and supplementary cash payment.

• make the payment direct to a member (by cheque or bank transfer, for instance) or directly to a DCS scheme or some other pension arrangement of the member’s choice.

Such payments will be earnings within the meaning of section 3(1)(a) (see NIM02010); and liable for Class 1 NICs under section 6(1) when paid direct to a member. In this respect, it makes no difference if the member is no longer, at the time the payment is made, an employee of the employer providing the DBS – see NIM02015.

The payment is disregarded in the calculation of earnings by virtue of paragraph 2(a) of Part 6 of Schedule 3 to the Social Security (Contributions) Regulations 2001on the grounds that it is a payment to a registered payment scheme (see NIM02716).