In April 2016, the basic State Pension will be replaced by the single-tier pension. From this date it will no longer be possible to contract out of the State Second Pension (S2P) using a final salary scheme. This article explains how S2P will work until the single-tier pension is introduced.
Since 6 April 2012, it has only been possible to contract out of the S2P using a final salary scheme. The ability to contract out using a money purchase or appropriate personal pension/stakeholder plan stopped on 5 April 2012.
To put this all in context, let 's have a brief look at the State Earnings Related Pension Scheme (SERPS), the predecessor of S2P first.
SERPS was introduced by the Social Security Pensions Act 1975 and began on 6 April 1978. It was a state pension in addition to the basic state pension for employed individuals (the self-employed were not eligible) and was based on earnings between the lower and upper earnings limits (LEL and UEL) commonly known as 'middle band earnings '.
When it was first introduced the benefit under SERPS was calculated as 1.25% of middle band earnings (which were revalued each year in line with national average earnings (NAE)) for each year of your working life, up to a maximum of 20 years. It is worth noting that you could use the best 20 years. The maximum was therefore 25% (1.25% x 20) of middle band earnings. This applied to everyone with a state pension age before 6 April 1999.
The Social Security Act 1986 made changes that meant that if your state pension age was on or after 6 April 1999 you were entitled to a reduced benefit of 20% of average revalued lifetime earnings for accrual from 6 April 1988. It was no longer possible to use the best 20 years earnings. If your state pension age was in the period 6 April 1999 to 5 April 2009 you would get between 20% and 25% for post 6 April 1988 accrual only.
SERPS accrual ended on 5 April 2002 when it was replaced by the State Second Pension.
Introduced by the Child Support, Pensions and Social Security Act 2000, S2P is the successor to SERPS and was effective from 6 April 2002. As well as providing an additional state pension for the employed, S2P gives an additional state pension based on earnings of £15,100 (2014/15) to:
S2P is not available to individuals who earn less than £5,772, the unemployed, students, individuals with no earnings who care for children older than 12 and the self-employed.
S2P is based on an earnings-related system similar to SERPS but with different accrual rates.
The Government 's aim was to ensure that low and non-earners received a greater benefit from S2P. To achieve this there were originally three bands of accrual.
Before 6 April 2010
The three bands of accrual were:
Band 1 - Benefit accrues at a rate of 40% (twice what SERPS provided). As previously mentioned those earning less than the LET are treated as though they had earned the LET.
Band 2 - The accrual rate is 10% for earnings within this band (half what SERPS provided).
Band 3 - Benefit in this band accrues at 20% (the same as SERPS).
Note - The LET is announced each year by the Government in the same way that the LEL and UEL are. The SET is calculated separately using these figures and is the sum of (3 times the LET) less (2 times the LEL rounded to the nearest £100 rounding down any exact sum of £50)
Individuals reaching state pension age before 6 April 2009 had enhanced accrual (as previously mentioned) under SERPS. These transitional arrangements were extended to S2P by increasing the accrual rate in each band. For individuals with a state pension age before 6 April 2009 an additional 1%, 0.25% and 0.5% of earnings was added to each band respectively.
So, if your state pension age was before 6 April 2009 you would not have received less under S2P than you would have done under SERPS.
From 6 April 2010 to 5 April 2012
From 6 April 2009 employers and employees with occupational pension schemes contracted-out of S2P received contracted-out rebates on earnings between the lower earnings limit and the upper accrual point. Employers and employees paid National Insurance contributions at 13.8% and 12% respectively on earnings between the upper accrual point (UAP) and upper earnings limit (UEL).
The number of bands reduced from three to two from 6 April 2010:
Band 1 - Benefit accrues at a rate of 40%. As previously mentioned those earning less than the LET are treated as though they had earned the LET.
Band 2 - The accrual rate is 10% for earnings within this band.
From 6 April 2012 From this date the accrual under band 1 became a flat rate. The level of pension is announced annually in the Social Security Pensions (Flat Rate Accrual Amount) Order and is £92.00 p.a. for 2014/15.
The two bands from 6 April 2012 are:
Band 1 - Benefit is a flat rate of £92.00 p.a.. As previously mentioned those earning less than the LET are treated as though they had earned the LET.
Band 2 - earnings between the LET (£15,100) and the UAP (£40,040). The accrual rate is 10% for earnings within this band.
S2P - the benefit calculation
The calculation for the S2P is based on a three-step process.
The examples below show how this works in practice for post 6 April 2012 accrual, assuming earnings are revalued to state pension age at approximately 2.5% per year.
John, age 55 and a builder, has earnings of £42,000 and a working life of 46 years.
Calculation of earnings in each band for 2014/15 tax year.
Assume that the revalued earnings are £31,925.
Total S2P benefit for 2014/15 tax year is £161.40.
Julie, age 55 and a nurse, has earnings of £22,000 and a working life of 46 years.
Calculation of earnings in each band for 2014/15 tax year.
Assume that the revalued earnings are £8,833.
Total S2P benefit for 2014/15 tax year is £111.20.
Note - In both examples the S2P benefit would be converted into a weekly amount.
SERPS and S2P will be calculated separately and individuals will be entitled to both a SERPS and a S2P benefit at state pension age, assuming of course that they were in both SERPS and S2P.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.
Published 27 April 2004
Updated 24 June 2014