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Opting Out
Pensions Beginners Page
Welcome to the seventh in a series of articles designed to introduce readers to some pensions' related topics.
Opting out
Many people will have heard the term 'opting out'. This article considers some of the implications for someone who chooses to opt out of their company pension scheme.
Compulsion
Prior to 1988, companies could make it a condition of employment that an employee joined their company pension scheme. However, from April 1988 it became unlawful to enforce pension scheme membership - employees gained the right to choose whether or not to join, or remain a member of, their company pension scheme. This coincided with the promotion of freedom of choice by the government at that time and availability of alternative personal pensions.
Opting out considerations
If someone chooses to opt out of, or not to join, an occupational pension scheme offered by their employer they will obviously lose out on valuable income in retirement. Some of the other considerations are explained below. Of course the precise details and relevance will depend on the occupational pension scheme involved and the personal circumstances of the individual.
Employer contributions
If the individual decides to opt out, he will lose the benefit of the employer contributions. The employer is unlikely to contribute to an alternative personal pension chosen by the individual.
Employee contributions
Many schemes ask employees to contribute. The rate will vary from scheme to scheme but is frequently in the range of 4%-8% of salary. In recent years the employee contribution rate in many schemes has risen as the overall cost of pensions has increased.
Employee contributions are tax deductible so the reduction in an employee's "take home pay" will be lower than the contributions paid.
Opting out will save the individual from paying this contribution and it can then be used for other purposes (in cases of financial hardship this may be particularly important to an individual).
Death benefits
Death-in-service cover is often provided as part of the pension arrangements. This may include both lump sum death-in-service benefits (e.g. 4x salary life assurance cover) and provision for a spouse's pension payable on death-in-service.
Whilst some employers may provide life assurance cover regardless of pension scheme membership, the multiple is sometimes lower for non-members and many employers provide no cover at all for non-members. Few employers will provide a spouse's death-in-service pension to non-members. The employer may require the potential beneficiary (e.g. husband or wife) to sign an acknowledgment stating that they understand no benefits will be payable in the event of the employee's death.
Unfortunately, death can be unexpected through accident or illness. Should this event occur whilst the individual has opted out, family and loved ones may not receive any financial support from the employer.
Rejoining or joining at a later date
Scheme membership is often a one-off opportunity. If an employee chooses to opt out, or decides not to join when invited, they will often not be given a further opportunity to join later or joining may be subject to conditions such as medical acceptability.
Other benefits
The Scheme may provide benefits payable on ill health that will be lost if the employee is not a member of the scheme.
Some employers provide support and assistance to their pensioner community. This may be in the form of pensioner visitors, Christmas parties or hampers.
If an employee does not build up pension rights in the company scheme, they will not become a pensioner of that company and may lose these benefits after they leave.
Administration
If an employee decides not to join or if an existing member decides to opt out of an occupational pension scheme it is very often the practice for the pension manager or a HR representative to discuss their decision with them and ask them to sign a form saying that they fully understand the implications. In some cases the spouse is also asked to sign the form to ensure that they fully understand how they might be affected by the decision as well (as mentioned above).
Conclusion
The concepts behind opting out and the practical effects are controversial. There are some circumstances where opting out is sensible. However, pensions and financial security for an employee's family is very important. Decisions to opt out must be considered carefully taking into account the long and short term implications.
Ollie Clymo, March 2006.