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HMRC internal manual

National Insurance Manual

HM Revenue & Customs
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Class 1 NICs: payment for leaving a defined benefit pension scheme 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 bysetting up an occupational pension scheme. Broadly, there are two types of such schemes:

  • 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).

Typically, a DBS pays a pension that is based on the employee’s length of serviceand the amount of their final salary. In a 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 pastfew years, such schemes have become increasingly expensive. This is especially so as anemployer 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 (whethercurrent or former employees) of the DBS:

  • 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,

some employers are offering such members a cash payment. Employers (or formeremployers) 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.

However it is referred to, such a payment is:

  • “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.

But where the employer (or former employer) makes payment direct to an alternativeregistered pension scheme (see NIM02715):

  • 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 2001
  • on the grounds that it is a payment to a registered payment scheme (see NIM02716).