Once again we are very grateful to one of our website visitors for asking this question.
Of all the subjects discussed in the world of pensions “contracting out” is perhaps one of the most confusing. Furthermore we could write hundreds of words about the history of contracting out and still not get to the point of the question. We will therefore keep things very simple, but nevertheless will cover the main point.
It would help if we could briefly describe what contracting out is and what it attempted to do.
Everybody who pays national insurance contributions builds up an entitlement to the State Old Pension. Governments were concerned that people may not be saving enough towards their pension and that the State Pension may not be enough to provide for their retirement. They therefore introduced a top-up pension to the state old age pension called the “State Earnings Related Pension Scheme” more commonly known as SERPS. This pension was paid for by using some of the National Insurance contributions made by an employee and their employer and paying them into SERPS. This takes us to an important first point, only people who were in employment (not self-employment) could qualify for SERPS.
SERPS was later replaced by the Second State Pension (S2P), however for the purposes of this article their differences are immaterial as their treatment (assuming you have contracted out) is the same when it comes to taking lump sums and income.
If you have not contracted out then when you retire you will receive an additional income from the state alongside the main State Old Age Pension.
People who chose to contract out decided to forgo the benefits offered by the state (for the top-up pension only) and instead had some of their National Insurance (NI) contributions and some of their employers NI Contributions diverted into a personal pension. This was in effect a personal pension in their name with a commercial insurance company. In other words an individual chose to come out of the state top-up pension, in favour of a personal pension in their own name – they contracted out.
The insurance company needed to keep the contracted out pension money separate from other personal pension money as special conditions did apply to them, however these special conditions no longer apply.
To be very clear, if you still hold a contracted out pension then you can do whatever you want with it, in line with current pension rules. This means that you can take a lump sum and an income from it, you can use temporary annuities and with profits annuities and income drawdown. This also means that you can take just the tax free cash from the fund and leave the rest invested until later. If you want the pension lump sum only from your contracted out pension fund, then we can help you achieve this objective.
If the only personal pension you hold is a contracted out fund, then should you qualify, you could take all of the fund as a lump sum, if you met the Trivial Pension rules.