How To Contract Out

You may decide to contract out of the State Second Pension (see Contracting Out). Some private pension schemes are set up as contracted out schemes. If you join, you should be made aware that you will be contracted out of State Second Pension through the pension scheme. Many pension schemes have general scheme rules that apply to all members, and if the scheme decides to contract its members out, you too will be contracted out. Similarly, if the pension scheme does not contract its members out, you will remain contracted in. You may be given the choice of contracting out if your pension scheme has no specific rules regarding contracting in or out. In this case it is important to weigh up the advantages and disadvantages of contracting out of S2P. The individual terms and conditions of your pension scheme will determine whether contracting out will be worthwhile for you, but there are some general points to remember:

• S2P guarantees you a certain amount of state benefit when you come to retire. Be sure that your alternative investments are set to give you returns at least as good as those you would have from S2P.
• The government can change the rules of the state pension system at any time, and so the exact benefit you will be entitled to receive may be subject to change before you reach retirement.
• If you are offered a great investment opportunity with a high rate of return, it may be worthwhile contracting out.
• Many pension schemes are now contracting back into the State Second Pension because alternative saving schemes proved unreliable and yielded lower returns than S2P would have done.
• S2P is a non-contributory additional pension scheme, based on your earnings. Your alternative additional pension scheme may require you to make contributions.
• Older people are less likely to benefit from contracting out because their alternative investments have less time to mature and provide good returns before retirement.
• Contracting out is being abolished in April 2012.

If you do decide that you want to contract out of the State Second Pension scheme, you will be contracting out through your current pension scheme, and your pension scheme administrator should be able to advise you on how to go about doing so. At the same time they should explain the benefits and drawbacks of your decision and give you an idea of whether you are making the right choice based on your individual situation. You will have to sign a declaration, provided by your pension scheme administrator, which asserts that you wish to be contracted out of the State Second Pension scheme.

You cannot contract out of the State Second Pension if you have no alternative pension scheme into which your NI rebate can be paid. There is no option to contract out of an additional pension scheme entirely, and take your NI rebate as a cash sum. There is only the option to contract out of the State additional pension scheme in favour of an independent additional pension scheme. For this reason you will need to be a member of a non-state pension scheme (see Non-State Pensions) before you are able to contract out. You may be able to contract out with the assistance of a pension provider, who will then set up a contracted out pension scheme for you when your declaration has been processed. You will usually be required to contribute more to your non-state pension scheme than you would have done if you were only paying National Insurance contributions. However, you may be entitled to tax relief on your pension savings. For more information see Tax Incentives for Saving.

For further details of contracting out see After contracting out.