The state pension system is a complex animal, even after the pensions simplification measures that came in last year. But there are some basic facts that can make your decisions easier.
In a nutshell the state pension system is made up of two tiers - a flat-rate basic state pension and an earnings-related second state pension (S2P). Everyone gets a basic state pension, if you have made the requisite National Insurance (NI) contributions, but S2P is more complex. It replaced the state earnings-related second pension (SERPS) in April 2002 - and is more generous. As it is based on your salary, the more you earn, the bigger your S2P (up to a maximum limit).
Many occupational schemes contract out of S2P whether you want to or not. But with personal pension schemes, the choice is yours. Contracting out means you completely give up the money you would get from the S2P and in return you have either a reduced NI contribution - or a NI rebate, which can be put into a private plan.
The reason for contracting out is that, in theory, by letting the government off the hook for giving you a pension, you can save more in NI and contribute more into a specific contracted out private plan. Depending on how you invest it, you could out-perform the Government plan.
However, there is a risk in contracting out. Your benefits from the government are, to an extent, guaranteed. The benefit your receive from them, particularly over the last few years running up to retirement, is likely to outweigh the risk involved in taking your money away and placing it in a volatile asset such as equities (and paying the charges which come with a private scheme).
Therefore, whilst it might seems a good idea - taking control of your own future rather than leaving it to the Government - do make sure you do your calculations carefully and check the assumptions are realistic for your situation.
We can guide you through the issues involved and assist you in making a decision which is most suited to your circumstances and preferences.
Source: Marketing Hub - 01/10/2008