Notes

Using a stakeholder pension to contract out of the State Second Pension

You can use a stakeholder pension to contract-out of the State Second Pension (S2P), but it’s not an easy decision.

Everyone in employment earning above the lower earnings limit (a minimum level of earnings set by the Government for State benefit purposes) is automatically included in the S2P unless they decide to leave it or are contracted-out through an employer’s occupational pension scheme. Leaving the S2P is called ‘contracting-out’. If you contract-out, you give up your S2P entitlement and instead build up a replacement for it in your own private pension arrangement, such as a stakeholder pension.

Whether you would be better off contracting-out of the S2P or staying in it depends on your own personal circumstances and attitude to investment risk.

An independent report written for the FSA in August 2005 says that, in purely financial terms, most people who contract-out or stay contracted-out this year are likely to get a lower pension than if they were in S2P. The report looks at recent trends and makes assumptions about future investment returns and interest rates. It also assumes that S2P will stay in its current form. The government is currently looking at pensions reform and it is difficult to predict what will happen to S2P in the future.

If you have already contracted-out through a personal or stakeholder pension, you should review your decision now. Your decision is about the future but you should review it every year. It does not affect past years in which you were contracted-out.

You may wish to get advice on what may be the best thing for you to do. See Where to get more help.

For more information about contracting out, read the FSA Factsheet: The State Second Pension and contracting out. You can view or order this factsheet online at Consumer Publications or from the FSA Consumer Helpline on 0845 606 1234.