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SERPS

Pensions can be hard to get to grips with. This is partly because, for many, old age seems a long way off and pension provision a low priority. It is also because pensions are complicated. But there can be a considerable period of retirement to provide for, and to ignore planning for this time could lead to hardship.

The basic State pension increases in line with the rate of inflation, but it is not linked to the increase in average earnings. This policy has been followed by the current and the previous Government. The effect is that the value of the basic State pension in relation to the income of non-pensioners is bound to deteriorate through time. The standard of living of a pensioner who is reliant only on the basic State pension is generally low and, given the continuation of current policies, will not improve in the future.

SERPS (the State Earnings Related Pension Scheme) was also known as the additional State Pension. It ran from 6 April 1978 to 5 April 2002 when it was reformed by the State Second Pension. A person who was in employment may have paid into SERPS.

SERPS is paid from State Pension age to the person who has contributed to the scheme. There are also conditions that allow some or all of a person's SERPS entitlement to be inherited by their spouse when the SERPS contributor dies. From 6 October 2002, the maximum amount a person can inherit will now depend on the date that their late spouse would have reached State Pension age.

A person may have joined a private pension scheme instead of SERPS.  This is called 'contracting-out'.

Any SERPS earned from April 1978 to April 1997 is reduced if a person was contracted out during that period. This reduction is called the 'contracted-out deduction'.

From April 1997 to April 2002, a person who was contracted-out could earn no SERPS at all.

The State Second Pension provides a more generous additional State Pension for low and moderate earners. Access has also been extended to include certain carers and people with long-term illness and disability whose working lives have been interrupted or shortened. The inherited SERPS rules do not apply to State Second Pension. The maximum amount of State Second Pension a person may pass on to a surviving spouse is 50%.

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Contracting out

If you are an employed earner with annual earnings above a certain amount (?4,108 in 2004/05) you cannot leave the basic State Pension. However, you can if you wish, choose to leave the additional State Pension and join a private pension scheme instead. This is called 'contracting out'.

If you choose to contract out by joining your employer's contracted-out occupational pension scheme, both you and your employer will pay lower, reduced rate National Insurance contributions. When you retire, your second pension will come from your employer's scheme and not from the additional State Pension. Although, most people will continue to build up a small entitlement to the additional State Pension as well.

You can also contract out with a stakeholder pension or a personal pension. If you do this, instead of paying lower National Insurance contributions, once a year the Inland Revenue will pay directly into your pension a rebate of your National Insurance contributions. The rebate is intended to provide benefits broadly the same as the additional State Pension given up.

You can also join a Stakeholder Pension scheme or a personal pension scheme without contracting out of the additional State Pension, but if you do this, you won't get the rebate.

You will usually get tax relief on your contributions to a private pension scheme. With a basic rate of income tax of 22 per cent, every ?100 that goes into your pension costs you ?78 (based on the tax year 2004/05). If you pay income tax at the higher rate of 40 per cent, every ?100 that goes into your pension fund costs you ?60 (based on the tax year 2004/05).

Some occupational schemes and some personal pensions are organised on a 'rebate-only' basis. This means that the only money being paid into the scheme is your National Insurance contributions rebate.

If you have chosen this sort of second pension, it will give you roughly the same pension you would get from the additional State Pension. You may still need to think about whether this will be enough to support the lifestyle you want when you retire.

From 6 April 2003 the State Second Pension gives employees earning up to ?26,600 (in 2004/05 terms) a better pension than SERPS, whether or not they are contracted out.

Most help goes to those who earn less than ?11,600 from 12 April 2004.

A person contributing to a contracted-out personal pension earning less than ?11,600 from 12 April 2004 in a tax year will also get a State Second Pension top-up for that year. The top-up reflects the more generous additional State Pension provided by State Second Pension.

If you are not sure what is the best choice for you, you may want to get further help. If you want to know more about contracting out , please see Contracted-out pensions - Your guide (PM7).

For latest info always check with the Pensions Service

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What else should I know

If you contributed to the additional State Pension before April 2002 through SERPS, there is some important information you need to know about the percentage of SERPS that you may be able to pass on to your spouse if you die.

More information on inheriting SERPS is available on this website or you can read or print our leaflet 'Important information for married people - Inheritance of SERPS'.

You may pass on only a maximum of 50% of your additional State Pension from State Second Pension.

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More information

To find out more about additional State Pensions (SERPS and Second State Pension), read and print A guide to State Pensions.

For more information contact The Pension Service.

You can read or print or request copies of our guides and claim forms on this website.

You can apply for a Pension Forecast by reading or printing the Pension Forecast form from our resource centre.

Occupational pension schemes

Occupational pension schemes are run by the company you work for. The scheme may be non-contributory, in which case you will pay nothing, or contributory, in which case you supplement your employer's contribution with perhaps 3-5% of your earnings.

It may be possible to further increase your contribution rate by buying added years or by making Additional Voluntary Contributions (AVCs). This can represent a sound investment but only a minority of people do it.

Occupational pension schemes have a number of tax advantages, though there are limits to the size of pension you can build up. The Inland Revenue rules are complicated, but currently you are not allowed to contribute more than 15% of your earnings each year, whilst your pension on retirement is limited to 2/3 of your final salary, some of which can be taken as a lump sum.

Very few people who are members of such schemes will retire on the maximum benefit - perhaps only 5%. If you belong to an occupational pension scheme, what pension are you likely to get if you stay with the company for the rest of your working life? How much would it cost to buy added years? You cannot be sure that your total pension in retirement will be adequate unless you know the answer to these questions.

Most people do not stay with the same company throughout their working lives. At present, the average employee changes jobs at least five times. If you change jobs, it is important to consider whether it is in your best interests to leave your accumulated pension rights in the occupational scheme of the first company, and take what is called a deferred pension, or transfer your accumulated funds, via a transfer value, to the new company's scheme or to a PPP.

Personal Pension Plans

PPPs are usually run by insurance companies and are taken out by the self employed and people who are not in an occupational pension scheme. They are a form of savings scheme, where the contributions you pay in managed on your behalf and invested in a range of assets, including shares. If the company which employs you will not contribute to your PPP, but will contribute on your behalf to its occupational scheme, you may be better off taking that option.

The tax benefits of a PPP are similar to those of an occupational pension scheme. The main advantage is that the Inland Revenue gives tax relief on your contributions, both at the standard and higher rates of income tax. Thus, if you are a standard rate (23%) taxpayer, your contribution is 77 out of every 100 that goes into your pension.

There are limits on the size of the contributions you can make to the PPP. These are related to your earnings.

Take time over choosing a PPP provider. This is effectively a savings contract for perhaps 20, 30 or 40 years. You should satisfy yourself on a number of points.

If the savings scheme is for 20 or more years, then it is quite possible that you will find yourself squeezed for income at some point. You may become unemployed and want to take a break from contributions. How will the plan accommodate this? If you move to a job with an occupational pension scheme, can the PPP be frozen and what implications will that have?

The PPP invests your contributions. Make sure you understand how risky these investments are. Will the PPP keep all your funds in shares as the end of the plan comes in sight or will it shift some of the accumulated funds into money-based investments? The latter is a safer approach as it avoids the consequences of your retirement coinciding with a Stock Market slump.

Once the plan ends, the accumulated funds from the plan are used to buy you an 'annuity' which provides you with a regular income.

New Government proposals

The basic State pension alone will not provide a sufficient income for most people to have a comfortable retirement. The Office of Fair Trading has pointed out that most existing occupational pension schemes and many personal pension plans are unsatisfactory and has called for a new product. The Government is now developing proposals for a new type of pension that should meet many of the Office of Fair Trading's concerns. This is to be called a Stakeholder Pension. The hope is to provide a simple, flexible second pension. It is not clear whether this will be compulsory or voluntary. If it is voluntary it is important that consumers make realistic provision to such a scheme.

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