FOOL SCHOOL
Pensions: SERPS & Second State Pension

May 24, 2002

The basic pension replaces your lowest slice of income (that is, up to £75.50 per week currently). The State Earnings-Related Pension Scheme (SERPS), or the Second State Pension (SSP) from April 2002, is designed to top up your income from £75.50 per week to perhaps as much as £500 per week depending on how much you've earned over the years. It's 'earnings-related' because the more you earn, the more you'll pay in National Insurance contributions, so the more you'll get -- up to a maximum of £500. The main difference between SSP and SERPS is that the former is designed to provide a higher retirement income for low earners.

However, as you go from £75.50 to £500, the lower the percentage of your income that is replaced becomes. This means that someone earning, say, £200 per week will retire on a higher percentage of their pre-retirement income than someone who was earning £500 per week (although they will, of course, get less actual money). Income above the £500 per week level does not get replaced under SERPS and the scheme is only available for employees, not the self-employed.

If you want, you can choose to opt out of SERPS/SSP. This is called 'contracting out'. The effect of this is that part of your National Insurance payments, which would have gone towards providing your SERPS/SSP benefits, instead get paid into your occupational or personal pension. In certain cases your pension scheme will more or less guarantee to pay out at least the SERPS/SSP benefits that you have given up. Basically, all you are doing is replacing SERPS/SSP with your own arrangements.

Whether or not to contract out of SERPS/SSP is a tricky question and depends on several factors. On the whole, the more you earn, the younger you are and the better your view of future stock market returns, the more likely it is to make sense to contract out. Similarly, the less you earn, the older you are and the worse your view of future stock market returns, the more likely it is to make sense to stay put with SERPS/SSP. 

For more on this subject see the Pension Guide website.

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