For employees, the state pension is based on earnings between the lower earnings limit ( LEL) and upper earnings limit (UEL) and by and large you pay for your pension rights through the National Insurance contributions made on these earnings. However, since April 2000 people earning more than LEL but less than the ‘primary threshold’ , which is £89 a week in 2003-4, do not pay contributions but still build up state additional pension.)   You can give up your state additional pension (or in some cases part of it) and instead built up a pension through an occupational pension scheme, personal pension or stakeholder pension scheme. This is called ‘contracting out’. If you belong to a contracted out occupational pension scheme, you pay National Insurance contributions at a lower rate. The pension scheme must promise to pay you certain benefits at retirement, or it must invest at least a given amount that will be used to provide retirement benefits. Our employer might ask you to make contributions to the scheme to help to pay for these benefits. If you decide to contract out through a personal pension or stakeholder scheme, part of the National Insurance contributions you have paid are rebated and put direct into our pension plan, where they grow and must be used to provide certain retirement benefits.

Case history

Tim was born on 10 March 190. His working life runs from 6 April 1955 to 5 April 2004, a total of 49 years. Of these 26 years fall in the period earning around £25000 a year) and a member of SERPS (State Earnings Related Pension Scheme)  and S2P (State Second Pension) since they started. To work out his SERPS pension, the relevant earnings are taken for each year from 6 April 1978 to 5 April 2002 and revalued in line with earnings inflation. They total £407,161. This figure is divided by 26 in other words by the total years covered by both SERPS and S2P (not just the years covered by SERPS) and the relevant percentage worked out. Tim’s SERPS pension comes out to £69.54 a week. Next his S2Ppension is worked out. The relevant earnings are taken for the years he is in S2P (just 2002-3 and 2003-4). They are revalued in line with earnings inflation. This time the relevant percentage is worked out first and the result is then divided by 26 (the total years in both SERPS and S2P). His S2P pension comes to £6.87 a week. Tim’s total state additional pension is £69.54 + £6.87 = £76.41 a week.