State Second Pension


The State Second Pension, or Additional State Pension, was introduced in the UK by the Labour Government on 6 April 2002, to replace the SERPS. The main aim of this change was to skew existing Additional Pension benefits in favour of low and moderate earners at the expense of higher earners and to extend access to include certain carers and people with long-term illness or disability for the first time.
The Additional State Pension was replaced for new pensioners by the new State Pension on 6 April 2016.

Differences between SERPS and S2P

Before April 2002, AP was provided through the State Earnings-Related Pension Scheme,. SERPS was a career average pension scheme, based on the band of earnings each year between a "LEL" or '"Lower Earnings Limit"' and a "UEL" or '"Upper Earnings Limit"'. Any SERPS entitlement already built up is retained and revalued each year in line with the changes in average earnings until State Pension Age. It is then added to any Basic State Pension payable, and the combined amount uprated thereafter in line with the index of retail prices.
S2P gives all employees earning up to £32,592 a year a larger pension than SERPS, regardless of whether they are "contracted out" or not - with most help going to those in the '"lowest"' earnings - known as the "LET" or '"Low Earnings Threshold"'. The accrual rates within each band of earnings are:
EarningsLEL to LETLET to to UEL
£5304 - £14,400£14,400 - £32,592£32,592 - £42,475
SERPS20%20%20%
S2P40% 10%20%

Earnings in the lowest band are treated as though they were actually at the threshold of the next band. Thus, under SERPS, earnings of £10,000 a year would produce a pension of just £939 a year - 20 per cent of - whereas under S2P the same earnings would lead to a pension of £3638 a year - 40 per cent of - nearly four times as much. However, under SERPS earnings of £25,000 a year would produce a pension of £3939 a year - 20 per cent of - but under S2P only £4698 a year - 40 per cent of £9096 plus 10 per cent of. At the "3 x LET - 2 x LEL" threshold SERPS and S2P pensions are equal and the same rate of accrual applies above that.
These percentages are the entitlement of employees who have contributed to the scheme for a full working life. This is defined as the number of years between age 16 and State Pension Age. If the employee was over age 16 on 6 April 1978, their working life is defined as the number of years between 6 April 1978 and their State Pension Date.

Contracting out

If an employed earner had annual earnings above the LEL they become part of State Pension scheme, and must pay some National Insurance contributions. However they could choose to leave the Additional Pension element of the State Pension by joining a private pension scheme or holding a private pension plan instead. This was called "contracting out". There were two kinds of contracting out concerning the Additional Pension.
Through a 'contracted-out employment' scheme:
If chosen to contract out by joining an employer's occupational pension scheme, both the employee and their employer paid reduced rate National Insurance contributions.
When the employee retires their second pension then comes partly from the employer's scheme rather than the Additional Pension, although most people will continue to build up some entitlement to AP at the same time. Because they will continue to pay some National Insurance, such employees will receive the difference between the higher level of the S2P and the lower level of SERPS which they have contracted out from when they come to draw on their State Pension. This form of contracting out lasts as long as the individual remains a member of the employer's scheme - usually as long as they remain in a particular job. Once they leave a job, and resume employment elsewhere, they default to being 'contracted in', unless moving directly in to contracted-out employment elsewhere.
Through an Appropriate Pension plan:
A person could also contract out of Additional Pension with a stakeholder pension or a personal pension plan which they may nominate. This vehicle was then known as an Appropriate Personal Pension, or APP. If they did this, instead of their paying lower National Insurance contributions, once a year HM Revenue & Customs paid directly into their APP a rebate, sometimes known as a Minimum Contribution. This rebate is intended to provide benefits broadly the same as the Additional Pension given up - that is, full S2P. Its value is therefore determined by reference to the individual's age and level of earnings that year but not directly by how much they may pay in National Insurance in that particular year. This second form of contracting out occurs one year at a time - each year the individual has the option to elect to contract back into the full S2P Additional Pension. Where an employee earns less than the LET their rebate will be based on their actual band earnings so that they would still receive some S2P through their State pension later - equivalent to the difference remaining.
If an individual chose this sort of second pension, in lieu of being 'contracted-in', it should give them roughly the same amount one would get from the Additional Pension. Whether it does or not rests on the investment returns from the rebate being sufficient to purchase additional income One may still need to think about whether this predetermined level of pension would be enough to support the lifestyle one had planned when they retired.
It was also possible to use a stakeholder pension or a personal pension plan to build up retirement funds without contracting out of the Additional Pension, but if this was done, they was no rebate. A person will usually get tax relief on all their contributions into a private pension at the basic rate of income tax irrespective of income tax actually paid. If they have paid income tax at the higher rate also, their contributions are relieved at this rate, but only against that income on which the higher rate was paid.

Relative merits of contracting out

Although the National Insurance rebate is intended to provide benefits broadly the same as the Additional Pension given up, there is controversy over whether the rebates are sufficient based on current projections for investment returns and annuity rates. Many IFAs and Personal Pension providers are now encouraging some or all of their customers to contract back in.
Those who contract in gain the security of a known pension level which is not determined by investment returns or annuity rates but lose the flexibility to take their pension before state pension age, receive a tax-free lump sum payment on retirement.
One advantage of contracting out is that the funds are invested privately on behalf of the individual. This means that they are protected against future government changes to the pension system.

Help for lower earners

As previously stated, this comes from
In 2006 the government announced changes to both the Basic and the Additional Pension. Specifically it was announced that