The second state pension: Are you in or out?

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Advice from the Pension Service
New State retirement ages

Fashions change, even in the world of pensions. Back in the 1990s, people were urged to opt out of the state second pension (then know as Serps; now called S2P) in order to maximise their retirement earnings.

The second State pension is the earnings-related top-up to the state pension. If you contract out through a personal or stakeholder pension, the government will pay some of your National Insurance contributions (called rebates) and income tax relief into a personal or stakeholder pension of your choice.

The private pension replaces some or all of your S2P.

If you are a member of your employer's contracted-out occupational pension scheme, both you and your employer will pay reduced rate National Insurance contributions.

It is estimated that nine million employees have opted out and more than two million people have opted out individually. In this case money is paid by the government into a private pension account worth £1,100 a year for a 25-year-old earning £25,000 a year, and £2,400 a year for a worker aged 60 on the same salary.

Now, however, the advice is changing. An independent report by the Financial Services Authority last year stated that people who stayed contracted out of the second state pension were likely to receive a lower pension than if they stayed in.

Insurance companies and actuaries say most people, particularly those who are older and the lower-paid, should consider going back into the state system.

The FSA report was based on past trends and assumptions about future investment returns and interest rates.

Insurers Scottish Widows and Norwich Union are automatically returning contracted-out customers to S2P.

The consenus is that the government's shrinking of rebates means opting out is less attractive then it once was.

What should you do?

It is difficult to predict what is going to happen to the S2P, as the government is currently reviewing the whole system. So there is a small element of uncertainty if you decide to opt in.

It is also worth remembering that the government is not honour-bound to deliver its pensions promise.