Contracting out of the State Second Pension

The Government has in place a State Second Pension (S2P), which is in addition to the Basic State Pension. It is available to employees and is earnings related, with funding coming from your National Insurance Contributions (NICs). It was previously known as the State Earnings Related Pension Scheme (SERPS).

The Government give people the option to contract out of S2P into a personal or stakeholder pension. NICs are diverted into this private pension pot, together with the income tax relief. The pension this pot provides replaces S2P.

The fund grows as any other money purchase pension scheme would do. It is based on the level of contributions, the number of years the fund has to grow and the performance of the assets the funds are invested in. As with all such investments, returns are not guaranteed and so funds can go down as well as up.

At retirement the pension is used to purchase an annuity which will provide an income, which will depend on the annuity rates prevailing at the time of retirement. There are specific rules surrounding this annuity for example, if you have a spouse or civil partner at retirement, the annuity must pay 50% of the income to them if you die first.

Twenty-five percent of the fund can be taken as a tax-free cash lump-sum when you retire. This will reduce the amount available to purchase an annuity.

Whether it is appropriate to contract out from the S2P depends on individual circumstances and age, although it is possible to contract back in to S2P at a later date. The Pensions Service and Financial Services Authority have guides for those wondering whether to contract in or out.