What was contracting out and why might it reduce my State Pension?

Full answer

Contracting out was a feature of the UK pension system that operated for almost four decades before being abolished when the new State Pension was introduced, and it continues to affect the State Pension calculations of people who worked during that period, even though the scheme itself no longer exists. **What contracting out actually did** Between 1978 and April 2016, employees could be 'contracted out' of the additional State Pension (previously called SERPS, later the State Second Pension) if they belonged to a suitable employer pension scheme (or, for a period, a personal pension). In exchange, both the employee and employer paid a lower rate of National Insurance, and the money that would otherwise have gone towards building additional State Pension was instead paid into the workplace or personal pension scheme. **Why contracting out is relevant to the new State Pension calculation** When the new State Pension was introduced in April 2016, everyone's National Insurance record up to that point was converted into a 'starting amount', calculated under both the old and new rules, with the higher of the two figures used as your starting point. For people who were contracted out for some years, a deduction (broadly reflecting the additional State Pension they gave up during contracted-out years) is applied to the old-rules calculation, which can result in a starting amount below the full new State Pension rate, even with a reasonably long National Insurance record. **Why this is not necessarily a loss overall** The policy intention behind the deduction is that people who were contracted out already received the value of the foregone additional State Pension in the form of extra contributions paid into their private pension scheme instead -- so while their State Pension may show a deduction, they should, in principle, have a correspondingly larger private pension pot (or, for some older defined benefit scheme members, a Guaranteed Minimum Pension underpin) to make up for it. **How to check if this affects you** Your State Pension forecast (available via the gov.uk online service) will show your 'starting amount' as at April 2016 and whether a contracted-out deduction has been applied, alongside how many further qualifying years you may need (up to the maximum of 35) to reach the full new State Pension rate. If your starting amount was already at or above the full rate, you may not be able to add much further to your State Pension no matter how many more years you work, since the new system does not simply add up all 35 years from scratch. **Worked example** Someone with 38 qualifying years by April 2016, many of them while contracted out into a workplace pension scheme, finds their starting amount is £220 a week -- below the full new State Pension rate of £241.30 in 2026/27 -- due to the contracted-out deduction applied to the old-rules calculation. Because they have several years left before State Pension age, they can add further qualifying years (each adding roughly 1/35th of the full rate) to increase their eventual State Pension, up to the full new rate but generally no higher. **Practical tip** Check your State Pension forecast well before retirement to understand your starting amount and whether contracting out has affected it, and consider whether any private pension built up during your contracted-out years is being correctly tracked and accounted for, since it was intended to replace the additional State Pension you gave up.

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