Can individuals contract out?

If you are a member of a contracted-out occupational scheme you do not have any choice. You are contracted out and will not receive a State Second Pension for the years you are contracted out.

Everyone else who is employed can choose whether or not they wish to contract out and give up their State Second Pension in return for getting contributions made to a personal or stakeholder pension of their choice.

You need to actively opt out, otherwise you will build up State Second Pension. It is not a lifetime decision. You can opt out when you are young and opt back in again as you get older.

Neither you, nor your employer, pay reduced National Insurance contributions, but the tax authorities will pay part of your NI contributions into the pension you have chosen. The amount will depend on your salary and your age.

By law these payments must be saved in what is known as an Approved Personal Pension. An APP is governed by stricter rules than a normal personal pension to make sure it provides the same kind of benefits package as the State Second Pension:

• you can only use it to buy a pension once you are 60
• you cannot take any of it as a lump sum
• you can only buy an annuity that provides the same benefits for men and women
• you can only buy an annuity that provides a spouse's pension (except for money built up since 1997 if you are single)
• you can only buy an annuity that increases each year (there are separate rules for pre- and post-1997 contributions)

But although you have the right to contract out, this does not mean you should. While it was thought to be a good deal for most younger people once, the general view now is that people are better off staying with the state second pension. The Financial Services Authority say "An independent report which we published 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."

You can download the following useful pdfs from the Pension Service and FSA websites: Contracted out pensions - Your guide and Contracting out of the State Second Pension