Contracted-Out Pension Rights Explained

Contracting out is a term that appears frequently in UK pension statements, State Pension forecasts, and benefit illustrations — but its meaning is rarely explained. Between 1978 and 2016, millions of UK workers "contracted out" of the State Earnings Related Pension Scheme (SERPS) and its successor, the State Second Pension (S2P). This had significant consequences for both the State Pension and the private pensions those workers were enrolled in.

The contracting-out regime is now fully closed — it was abolished for all schemes from April 2016 when the new flat-rate State Pension replaced the two-tier system. But the legacy of contracting out continues to affect the State Pension forecasts and private pension benefits of everyone who worked during the contracted-out era.

Why Contracting Out Was Introduced

SERPS was introduced in April 1978 as an earnings-related supplement to the basic State Pension. The government recognised that requiring all workers and all employers to fund SERPS through National Insurance contributions would duplicate — and conflict with — the funding of existing occupational pensions and personal pension arrangements that provided equivalent or superior benefits.

The solution was contracting out: employers with qualifying defined benefit occupational schemes, and later holders of certain personal pensions, could opt out of funding SERPS (and later S2P) on behalf of their members. In exchange, both employer and employee paid reduced National Insurance contributions — the "contracted-out rebate." The employer's scheme (or the personal pension) took on the obligation to provide benefits equivalent to (or better than) SERPS.

Two Types of Contracting Out

COSR — Contracted Out Salary Related (DB Schemes)

The main contracting-out route for defined benefit occupational schemes was the Contracted Out Salary Related (COSR) framework. A COSR scheme contracted out by agreeing to provide a Guaranteed Minimum Pension (GMP) — a benefit that mirrored the SERPS entitlement the member would otherwise have accrued.

COSR contracting out was available from April 1978 until April 2016. It applied predominantly to large private sector DB schemes and all public sector DB schemes.

The National Insurance saving for COSR contracting out was significant: during various periods, the contracted-out rebate was approximately 1.6 to 3.5 per cent of relevant band earnings for employers, and 1.6 to 3 per cent for employees. These savings were not paid into the pension scheme — they were retained by employer and employee as a reduction in NI contributions payable to HMRC.

COMP — Contracted Out Money Purchase (DC Schemes and Personal Pensions)

Personal pensions and defined contribution occupational schemes could also contract out via the Contracted Out Money Purchase (COMP) framework. Under COMP, the NI rebate (for employer and employee) was paid into the personal pension or DC scheme as a "contracted-out contribution" — building up a ring-fenced pot known as "Protected Rights."

COMP contracting out was available from July 1988 until April 2012. The government abolished COMP contracting out in April 2012 because evidence showed that, for many low-to-moderate earners, the contracted-out rebates being invested in personal pensions were not growing sufficiently to replicate the SERPS benefits foregone. The Protected Rights accumulated under COMP were merged into general pension savings in April 2012 — they no longer exist as a separately tracked category.

The Contracted-Out Deduction (COD) on State Pension

The most visible legacy of contracting out for COSR scheme members is the Contracted-Out Deduction applied to their new State Pension.

When the new State Pension was introduced in April 2016, the DWP calculated a "starting amount" for each individual based on their NI record. For those who had contracted-out years via COSR, the starting amount included a deduction — the COD — reflecting the fact that, during those years, they paid reduced NI contributions and did not build up full Additional State Pension entitlement.

The COD is permanent. It cannot be reversed by paying voluntary NI contributions. It cannot be offset by additional qualifying years. It reflects the historical decision to contract out and is embedded in the starting amount calculation.

Example: An individual with 40 qualifying years and no contracting out might have a starting amount of £241.30 per week (the full new State Pension for 2026/27). The same individual with 15 years of COSR contracting out might have a starting amount of only £185 per week — the deduction reflecting the reduced NI paid during those contracted-out years.

This does not mean contracting out was a bad deal — the DB scheme should be providing pension income that more than compensates for the reduced State Pension. But it does mean the State Pension figure must not be interpreted in isolation. The full picture requires understanding both the State Pension (reduced by COD) and the private pension (enhanced by GMP and accrual obligations).

The NI Rebate Mechanism for COSR

During COSR contracting-out periods, the reduced NI rates applied automatically through the payroll. The employer and employee both paid a lower NI rate on earnings between the Lower Earnings Limit and the Upper Earnings Limit. The exact rebate rates varied over time and were set by HMRC actuarial teams to reflect the cost of the SERPS/S2P benefits being contracted out.

There was no direct transfer of money from HMRC into the employer's scheme for COSR contracting out — the saving was simply the reduction in NI contributions paid. The obligation fell entirely on the scheme: it had to provide GMP, properly revalued, to its contracted-out members.

COSR Obligations on the Scheme

Having contracted out, a COSR scheme took on binding statutory obligations:

1. GMP provision: The scheme must provide at least the GMP accrued during the contracted-out period to each member.
2. GMP revaluation in deferment: If a member leaves before retirement, the GMP must revalue in the deferred period (either by fixed rate or Section 148 orders — see the separate GMP guide for full detail).
3. GMP escalation in payment: Once in payment, the GMP portion has statutory rules about how it must increase annually.
4. GMP equalisation: Following the Lloyds Bank judgment in 2018, COSR schemes must equalise for the unequal treatment of men and women in their GMP structure.

These obligations remain in force regardless of whether the scheme is still open to future accrual. Even a scheme that closed to new members in 2000 still bears GMP obligations for all members with contracted-out service between 1978 and 2016.

Reconciling Your Contracted-Out Record

An important but often overlooked issue is the accuracy of contracted-out records. Both HMRC and employer schemes maintain records of contracted-out service. Discrepancies between the two records have been common — this was the subject of the national GMP Reconciliation Project (2014 to 2021).

If you have a DB pension entitlement that includes contracted-out service, it is worth checking:

1. Your HMRC National Insurance record — available via the HMRC personal tax account at gov.uk. This will show years as contracted out.
2. Your scheme benefit statement — compare the contracted-out dates against your employment records.
3. Your State Pension forecast — the COD shown in your forecast should correspond to the contracted-out years.

Discrepancies are possible. If the scheme has under-recorded your contracted-out service, its GMP obligation may be understated. If HMRC has over-recorded contracted-out years, your State Pension may be unnecessarily reduced. Both types of error have occurred during the reconciliation process.

Personal Pensions and Protected Rights (COMP Legacy)

For those who contracted out via a personal pension (COMP contracting out, 1988 to 2012), the story is different. The NI rebates were paid into the personal pension as protected rights contributions. These were invested in the personal pension and grew (or fell) with the investment performance of the chosen funds.

In April 2012, when COMP contracting out was abolished, all Protected Rights within personal pensions were converted into ordinary personal pension rights. The ring-fence was removed. If you have a personal pension that was used for contracting out before 2012, you may find a reference to "former Protected Rights" or "COMP" in historical documentation — but there is no longer any operational distinction between these funds and the rest of your personal pension pot.

For these individuals, the legacy of COMP contracting out is reflected in the COD applied to their State Pension starting amount — calculated based on the actuarial value of the SERPS benefits foregone, not the actual fund accumulated in the personal pension.

Contracting Out and Pension Transfers

When a COSR DB scheme member transfers to a SIPP or another pension arrangement, the GMP obligation does not transfer with the standard CETV — it is typically retained by the transferring scheme, which continues to hold the GMP liability. However, GMP can be transferred along with the CETV if the receiving scheme is a registered pension scheme willing to accept the GMP liability.

Most SIPPs do not accept GMP liability on transfer. This means that transferring out of a COSR scheme typically involves extinguishing the GMP obligation — the scheme pays the CETV and retains no further liability to the departing member. This has implications for regulated transfer advice: the GMP is a guaranteed, inflation-linked benefit that cannot be replicated in a DC environment and must be properly valued and considered in any transfer suitability assessment.

Contracting Out and Divorce

In divorce proceedings involving COSR DB pensions, the COD and GMP must be factored into the actuary's valuation of the pension benefits. Under-representing the GMP — particularly where GMP equalisation has not yet been completed — can lead to an inaccurate valuation that disadvantages one party.

Where a pension sharing order is applied to a COSR pension, the allocation of GMP between the scheme member and the former spouse depends on scheme rules and actuarial methodology. COSR pensions that include GMP require specialist actuarial expertise in the divorce context.

Compliance Notes

The contracting-out regime was governed by successive legislation including the Pension Schemes Act 1993, the Pensions Act 1995, and various regulations. It was abolished by the Pensions Act 2014 with effect from April 2016. HMRC and DWP have published extensive guidance on GMP obligations, COD calculation, and reconciliation — available at gov.uk.

Nothing in this guide constitutes legal, actuarial, or financial advice. Contracted-out rights and obligations are fact-specific and depend on the individual's scheme, employment history, and NI record. Regulated advice is recommended for any decision involving contracted-out pension rights, particularly CETV transfers, divorce, or State Pension shortfall assessment.

How Global Investments Can Help

Global Investments advises clients who hold DB pensions with significant contracted-out service — including those considering CETV transfers, those going through divorce proceedings, and those trying to understand why their State Pension forecast appears lower than their NI record would suggest.

We work with specialist pension actuaries and can facilitate GMP verification, contracted-out service reconciliation, and the integration of DB pension benefits (including GMP) into comprehensive retirement income planning. For clients with both UK and overseas pension entitlements, we ensure the contracted-out deduction on the UK State Pension is properly reflected in the overall income projection.