What is S2P and Contracting Out?
Contracting out is a rebate of some of your own and your employer's National Insurance contributions into your own personal or stakeholder pension scheme. This is a redirection of monies that would have been allocated for the State Second Pension, previously known as SERPS.
The State Second Pension is a top-up pension to your Basic State Pension, based on the average salary you earn during your working life.
Some people might be better off by having these contributions paid into their own stakeholder pensions instead. This is known as 'contracting out'.
If you are thinking of contracting out, you need to decide whether the National Insurance rebate paid into your stakeholder pension will provide you with a better pension than the additional state pension would.
If you do decide to contract out of the State Second Pension, you will still be entitled to any SERPS or State Second Pension that you built up before you contracted out.
As I'm only in the UK for a few years do these benefits differ?
If you are only living in the UK for a short period of time you will also contribute towards the State Second Pension through your National Insurance contributions, although the salary used to calculate your benefits when you retire will be frozen from the point you left the UK and not take inflation into account. This means that most people intending on only living in the UK for short periods it is even more beneficial for to contract out of the State Second Pension.
Can I get my National Insurance money paid straight to me?
Unfortunately, no, As you are contracting out of the State Second Pension, the government want to ensure the money is invested into an appropriate replacement vehicle to provide an income any time after the age of 50 (55 from 2010) and before 75. A personal or a stakeholder pension plan is an appropriate vehicle through which your rebate can be invested on your behalf until retirement.
What are the Risks?
The value of your fund can go down as well as up. The value will depend on the size of your rebate, the charges you pay and the rate at which your investment grows. The income you get at retirement will depend on interest and annuity rates available at that time, and may be less than the State Second Pension would have provided. There is no tax free lump sum, and the income received must be taken at any time between age 50 (55 from 2010) and 75.
Can I backdate my claim for previous years?
You can only backdate your claim to the start of the current tax year (6th April), future years will automatically be credited to your plan unless you contract back in to S2P or join a Contracted Out Company Pension Scheme.
When does the NI Rebate get paid to my stakeholder pension plan?
The rebate payment is usually paid to the insurance company around September/October from the last tax year, although it can take longer depending on when the tax office dealing with your affairs forwards on your NI rebate.
When can I access my 'Contracted Out Pension'?
Your NI Rebate will be invested until at least age 50 and at the latest 75, at which stage all of the fund built up must be used to provide an income for life.
What if I do not have a permanent NI number?
You cannot contract out of the State Second Pension without a permanent NI number, temporary NI numbers will be rejected by the Inland Revenue National Insurance Contributions Office.
What happens to my investment if I die?
If you die before retirement the pension will be paid to your spouse or, if not married, a lump sum paid to your estate. If you die after retirement your spouse will receive 50% of your pension.
Is a self employed person eligible to contract out?
A self employed person is not normally eligible to contract out. However, if such an individual is employed as well, they may be eligible to contract out
Are contracting out rebates included in the maximum contribution that I can pay into my Personal or Stakeholder Pension?
No, you can pay £3,600 pa or a higher amount based on net relevant earnings plus the amount of the rebate.
If I am in a company pension scheme can I still contract out?
Provided your company scheme is a "Contracted in" Scheme, yes you can still contract out of the State Second Pension.
It is important that you also read the following information when deciding whether to contract out.
Contracting Out Illustration - Information
These figures are only meant to give you a rough idea of the amount of pension you might get compared with the benefit that you would be giving up under S2P.
The benefits of contracting out decrease the nearer your earnings are to the lower earnings limit (currently ?4,368 for the 2006/07 tax year).
The figures show what might happen if we achieved an investment return of 1.0% or 3.0% each year on top of the rate of earnings inflation (National Average Earnings Index).
These are only examples and are not guaranteed - they are not minimum and maximum amounts. What you get back depends on how your investments grow and interest rates at the time you retire. You could get back more or less than this.
There is no guarantee that contracting out will provide you with equal or higher returns than remaining contracted in to the State Second Pension, S2P.
It is also important to note that when contracting out, if you are married at retirement, you also have to provide a spouses pension of 50% in the event of your death.
All insurance companies use the same rates of growth for illustrations but their charges vary. They also use the same rates to show how funds may be converted into pension income.
As this is a Stakeholder Pension there is no initial charge for setting up this contract, you only pay an annual management charge based on the value of the money invested. There is a maximum annual charge of 1.5% of the value of the funds you accumulate for the first 10 years and 1%pa thereafter.
Contracting out is a year by year decision. The figures shown are based on being contracted out for only three years (2006/07).
This illustration should be read in conjunction with the Key Features.
Your S2P entitlement depends on many factors such as age, sex and income, depending on government policy at that time. If you are unsure whether remaining within S2P is the best option, you should seek Independent Financial Advice.