There are some important changes to the state second pension (S2P) and contracting-out which took effect on 6 April 2009 with, as always when there is a downside, little fanfare from the Gov't of the day.
Previously, people built up S2P benefits on earnings between the lower and upper earnings limits, £4,680 and £40,040 in 2008/09. From 6 April, the upper accrual point (UAP) replaced the UEL as the higher threshold for earning S2P (stick with it). Although the UEL, the upper limit for paying national insurance contributions, will rise to £43,888 from April, the UAP will remain frozen at £40,040.
This means that people who earn above £40,040 and contract-out via a personal pension will pay extra national insurance contributions, yet see no increase in the rebate paid into their personal pension.
This will be exacerbated year on year as the UAP is fixed at £40,040 while the UEL generally increases each year in line with earnings.
It is unlikely that future contracting-out can be justified on the basis that the rebate received will outperform the S2P benefit given up alone. At most ages, good equity rates of return are required simply to match S2P, giving no incentive to give up a guaranteed benefit for one that depends on future investment returns and annuity rates. This is particularly the case for those over age 43 where rebates are capped. There are, of course, some circumstances which may make contracting-out more appealing for certain individuals. These might include :
* Where a potentially significant fall in post-retirement income can be contemplated i.e. they are not likely to be seriously dependent on their state pension in retirement, (wealthier people can afford to take more risk).
* Where the individual’s stated preference is to control the S2P rebate rather than have it controlled by government. This may be for personally held political beliefs, personal health reasons, etc.
* It should be noted that S2P has become more flexible, money built up by rebates is now treated very similarly to other pension funds, with the ability to take benefits before age 60 and the option to take 25% as a tax-free lump sum introduced from April 2006, so will appear a more attractive option to many.
In opposition to this fact are the very strong actuarial changes being made to the actual rebates received (see above).
And of course the real question ? What if the Gov't changes their mind ? Again.
Either way, if you are currently contracted out, you need to have another look.