SERPS and contracting out explained: what it means for your pension

SERPS, the State Earnings Related Pension Scheme, was the earnings-related part of the State Pension, paid on top of the basic State Pension. It ran from 1978 until 2002, when the State Second Pension replaced it. Many people were "contracted out" of it and built up a workplace or personal pension instead, which still affects their pensions today.

What was SERPS?

From April 1978, the State Pension had two parts: a flat-rate basic State Pension and an earnings-related additional State Pension. For its first 24 years, the earnings-related part was SERPS. Broadly, the more you earned within set limits, and the more National Insurance you paid, the more SERPS you built up.

SERPS covered the tax years 1978/79 to 2001/02. From 6 April 2002 it was replaced by the State Second Pension (S2P), which gave more to low and moderate earners. SERPS and S2P are both known as the additional State Pension. The government's fact sheet on the new State Pension and contracting out sets out these periods.

Who still gets it depends on your age:

• Men born before 6 April 1951 and women born before 6 April 1953 reached State Pension age under the old rules, so any additional State Pension is paid on top of their basic State Pension.
• Everyone younger gets the new State Pension, which started on 6 April 2016. Their National Insurance record under the old system, including any SERPS and S2P, was used to work out a "starting amount" for the new State Pension.

What does "contracted out" mean?

You couldn't opt out of the basic State Pension, but you, your employer or your pension scheme could choose to "contract out" of the additional State Pension. According to the government's guide to contracted-out pensions, while you were contracted out, some of your National Insurance contributions were either:

• lower than for people who were not contracted out, or
• paid into another pension, such as a workplace or personal pension

In return, the workplace or personal pension had to provide benefits to replace the State Pension you were giving up.

Contracting out was very common. The government says most people who were employed before April 2016 were contracted out at some point. All contracting out stopped on 5 April 2016, the day before the new State Pension began.

There were two main routes: through a defined benefit (final salary or career average) scheme, and through a money purchase or personal pension.

Contracting out through a final salary scheme

The government says members of defined benefit schemes are likely to have been contracted out. How the scheme had to replace your SERPS depended on when you built up your pension.

1978 to 1997: the Guaranteed Minimum Pension

From 6 April 1978 to 5 April 1997, a contracted-out defined benefit scheme had to promise each member a Guaranteed Minimum Pension (GMP). The GMP was designed to be broadly the same as the SERPS pension the member gave up.

GMP comes with its own rules. It is payable from age 65 for men and 60 for women, it is increased in set ways before and after it is paid, and it has been affected by court rulings on GMP equalisation between men and women. If your pension statement mentions GMP, this is where it comes from.

1997 to 2016: the reference scheme test

From 6 April 1997, schemes no longer had to promise each member a GMP. Instead, the scheme as a whole had to pass a "reference scheme test", certified by the scheme actuary, to show that its benefits were broadly at least as good as a standard benchmark scheme. The pension built up under this test is known as section 9(2B) rights.

Contracting out through defined benefit schemes continued until it was abolished by the Pensions Act 2014 from 6 April 2016.

Your contracted-out rights are simply part of your final salary pension, not a separate pot. Our guide to how defined benefit pensions work explains the wider picture.

Contracting out through a personal or money purchase pension

From the late 1980s, people could also contract out through a personal pension, a money purchase workplace scheme and, later, some stakeholder pensions. This is usually what people mean when they say they "opted out of SERPS".

Instead of the scheme promising a set level of pension, part of your National Insurance was paid into your pension pot. That money was held as protected rights, which had to be kept separately and used under special rules.

Two changes in 2012 brought this to an end:

• Contracting out on a money purchase basis stopped on 6 April 2012, under section 15 of the Pensions Act 2007.
• Protected rights were abolished from the same date. HMRC's guidance confirms that since then, former protected rights funds are payable in the same way as any other pension funds.

Unlike GMP, there was never a promise that a contracted-out personal pension would match the SERPS you gave up. What it is worth depends on how the money was invested and the charges taken.

How contracting out affects your State Pension

How your State Pension is affected depends on when you reach State Pension age.

If you reached State Pension age before 6 April 2016, the government says you might get no additional State Pension, or only a small amount, for the years you were contracted out. You still get the basic State Pension.

If you reach State Pension age on or after 6 April 2016, a deduction was made when your starting amount for the new State Pension was worked out. The government's guide Your State Pension explained says the deduction was applied to both possible starting amounts, one under the old rules and one under the new rules. How much was taken off depends on how long you were contracted out and what you earned at the time.

This is why some people's forecast is below the full rate of the new State Pension even after many years of work. The missing part was meant to come from your workplace or personal pension instead.

You may be able to increase your State Pension by adding qualifying years to your National Insurance record after 5 April 2016, by working or, in some cases, by paying voluntary National Insurance contributions.

What is COPE?

Your State Pension statement or forecast may show a Contracted Out Pension Equivalent (COPE). In its guide to State Pension statements, the Department for Work and Pensions describes COPE as an estimate of the additional State Pension you would have built up if you had not been contracted out, based on your National Insurance record.

Some key points:

• COPE is not paid by the government. It is not an extra amount on top of your State Pension.
• In most cases, your workplace or personal pension should include an amount broadly equivalent to it, although schemes don't usually show it separately. It is simply part of the pension you receive.
• It may not be fully replaced if, for example, your rights were moved to a pension that wasn't linked to your earnings and the investments didn't perform well, or a scheme was wound up without enough money.

Adding your State Pension forecast and your COPE figure together gives a rough idea of what your National Insurance record before 2016 should be worth across the State Pension and your private pensions.

How to check if you were contracted out

You don't need to pay anyone to find out. The main ways to check are:

1. Check your State Pension forecast. The government's Check your State Pension service shows your forecast, your National Insurance record and how you might be able to increase your State Pension.
2. Look at old payslips. The government says that if you have payslips from before 6 April 2016 with National Insurance category letters D, E, L, N or O, you were contracted out.
3. Ask your old employers or pension schemes. A final salary scheme can tell you whether you have GMP or section 9(2B) rights. A personal pension provider can tell you whether your plan used to hold protected rights.
4. Trace a lost scheme. If you've lost touch with a pension, the Pension Tracing Service can help you find the scheme's current contact details.

For free, impartial guidance on your pensions, you can contact MoneyHelper. If you have defined contribution pensions and are aged 50 or over, Pension Wise offers a free guidance appointment.

Why contracting out matters before a transfer

If you are looking into transferring a final salary pension, it helps to understand what your contracted-out rights mean.

• They are part of what you would give up. GMP and section 9(2B) rights are part of your guaranteed pension. If you transferred, they would be replaced by an invested pot that can fall as well as rise.
• Your State Pension deduction stays the same either way. The deduction was made because you were contracted out, not because of what you later do with your private pension. If you transfer, the part of your income that was meant to replace SERPS would depend on investment returns instead of a guarantee.
• They are safeguarded benefits. If your safeguarded benefits are worth more than £30,000, the law requires you to take advice from an FCA-authorised firm with the pension transfer permission before you can transfer.
• The FCA's starting assumption applies. Advisers must start by assuming that a transfer from a defined benefit pension won't be suitable, and the FCA's view is that a transfer is unlikely to be suitable for most people. See the FCA's guide to defined benefit pension transfers.

If you left a contracted-out scheme years ago, your benefits may have been moved to a section 32 buy-out plan, an insurance policy that can carry a GMP guarantee.

Useful questions to ask your scheme include how much of your pension is GMP or section 9(2B) rights, how each part increases, and whether GMP equalisation is reflected in your transfer value.

Be wary of anyone who contacts you out of the blue offering to "unlock" or "reclaim" an old contracted-out pension. Check the FCA's ScamSmart site before dealing with any firm.

Frequently asked questions

Is SERPS still paid?

Yes, in the sense that SERPS you built up still counts. If you reached State Pension age before 6 April 2016, it is paid as part of your additional State Pension. If you reach State Pension age later, your SERPS years were used to work out your starting amount for the new State Pension. Nobody has built up new SERPS since April 2002.

What is the difference between SERPS and the State Second Pension?

Both were the earnings-related additional State Pension. SERPS applied from 1978 to 2002, and the State Second Pension replaced it from 6 April 2002 until the new State Pension started in April 2016.

Did I lose out by being contracted out?

Not necessarily. Your workplace or personal pension was meant to make up the difference. A final salary scheme had to meet legal minimums, while a personal pension depended on investment returns.

Can I claim back my SERPS?

There is no refund of SERPS or of the National Insurance you paid while contracted out. If you were contracted out, the value of the SERPS you gave up should be within your workplace or personal pension. Ask those schemes what you have, and check your State Pension forecast for any gaps you could fill.

If you have a contracted-out final salary pension and you're wondering how transfers and the advice process work, you can book a free, no-advice chat. It is general information, not advice, and there is no obligation.