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Contract killers

I have received a letter from my pension company along with several leaflets saying I should stop contracting out. What do you think?

Contracting out is a gamble. Originally, back in 1978, you could only contract out by being in a pension scheme that guaranteed to give you the same level of benefit or more. As we moved through different Governments in the late 1980s, we were offered the ability to contract out using a personal pension. It was here that the gamble was introduced.

At any given age and salary, you will earn a specific amount of state-earnings related pension, now called the state second pension. If you decide – and the decision is made each year – to contract out using a personal pension, then the Government will pay to your scheme an amount of money known as the National Insurance rebate. Unfortunately, it keeps changing the amount of this rebate.

The figure is calculated by the Government actuary and is deemed to give a reasonable chance of matching what you have given up by contracting out. The gamble in contracting out is that you hope that the National Insurance rebate invested in your personal pension will provide a bigger pension than one you have given up from the state. However, investment returns have collapsed, along with annuity rates, so this gamble is less likely to succeed.

Interestingly, although this is being quoted as the reason to stop contracting out, it is not the real reason. The pension industry is paranoid about any further misselling scandals. As you have the ability to stop contacting out on an annual basis, there is a question as to whether you are receiving advice in this matter. So everyone can be seen to have acted in your best interests, you have now received a letter suggesting you stop contracting out and go back into the comfort of the state second pension.

Unfortunately, that statement in itself is not true. Since conceived by Barbara Castle, Serps has undergone many changes. It is now only a small shadow of its former self. Very subtle changes, often introduced to take effect in 10 years time, have been introduced over the decades, meaning that today the amount of pension you were promised from Serps in 1978 is roughly half.

With all the talk about the pension gap, is the Government going to change the state second pension again? Is the state normal retirement age going to increase from 65 to 70?The fall in investment markets, dramatic collapse of annuity rates and fear of litigation have led to a generalisation that everyone should stop contracting out. Ironically, the Pension Act 2004 will change matters again. Originally, you could only take benefits from your contracted-out personal pension at state retirement age. Due to sex equalisation issues, this was reduced to 60 for men. At no time were you able to make the decision about the type of pension or take tax-free cash. You were also not able to invest via a self-invested personal pension.

But from April 6, 2006, not only will you have access to your pension fund to provide income at any time from 50 (55 from 2010), you will be able to take a quarter of your fund as tax-free cash. You will not have to buy an escalating pension and you will be able to self-invest your monies.

I am 55 and I have 35,000 in my contracted-out personal pension. I intend to stay contracted out. As soon as I am able, I intend to move my funds into my self-invested personal pension to help fund a residential buy-to-let property. I will retire at some stage when I will be able to take a quarter of all my fund as tax-free cash.

I do not believe contacting back into the state second pension is a viable proposition. I do not trust politicians. My problem is that professionally I cannot advise clients using such political statements and, therefore, while I intend to remain contracted out myself, my professional advice to you has to be to stop contracting out.

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