Contracting out
As well as the basic state pension, you may also be eligible for
the
additional state pension,
formerly known as the State Earnings-Related Pension Scheme (SERPS)
before it was reformed in April 2002.
It is now referred to as the
state second pension (S2P) and is
based on your earnings and how much Class 1 National Insurance you
have paid.
However, if your employer offers a pension scheme, it may decide
to opt out of the additional state pension – known as contracting
out. This means that if you join the company pension scheme, you
too will automatically be contracted out of the additional state
pension.
By contracting out, both you and your employer will pay lower,
reduced rate National Insurance contributions. When you retire,
your second pension will come from your employer's scheme and not
from the additional state pension.
If the scheme is contracted out on a money purchase – or defined
contribution– scheme, HM Revenue & Customs (HMRC) will also pay
an additional rebate direct to the scheme for investment on your
behalf. This is intended to compensate for the additional state
pension you've given up.
Stakeholder and personal pensions
You can also contract out with a stakeholder pension or
personal pension. Instead of paying
lower National Insurance contributions, HMRC will pay a sum of
money into your personal pension once a year. This will be a rebate
of some of the National Insurance you have paid and includes income
tax relief on your rebate.
Since 2002, some people have also been able to build up a small
entitlement to the additional state pension as well. This is due to
more generous state benefits for lower-income earners and aims to
prevent them being at a disadvantage when they contract out.
If you are considering contracting out of the additional state
pension, it is worth seeking professional advice to find out
whether this is the best option for you as there are a number of
factors that will need to be considered such as your age and level
of earnings. In some cases it may be more beneficial to continue
with the state system.
Important changes in 2012
Contracting out through money purchase, personal pension and
stakeholder pensions will be abolished from 6 April 2012. This
means that if you're contracted out through one of these schemes at
the time, you will automatically be brought back into the
additional state pension.
This means you will then pay the standard rate of National
Insurance contributions instead of the reduced rate.
