Your state pension could shrink if you “contracted out”

A magnifying glass state pension GBP concept — (Image credit: Getty Images)

The state pension is meant to be straightforward: if you've made at least 35 years of national-insurance contributions, you'll qualify for the full amount of the benefit, currently worth £230.25 a week. However, hundreds of thousands of people are discovering that this often isn't true – they're in line to receive less than the full amount because of how they saved for retirement decades ago.

The confusion stems from a major shake-up of the state pension that took effect in 2016. Before the changes, many people were entitled to two types of retirement benefit from the state – the basic state pension and an additional payment related to their earnings, earned through the State Earnings Related Pension Scheme (Serps) or the State Second Pension (S2P). Now, anyone reaching state pension age after 6 April 2016 receives this benefit. But when Serps and S2P were still running, working people had the option of “contracting out” of these schemes via a private pension. They paid less national insurance, with cash rebated into private pensions.

Contracted out? You may not qualify for the full state pension

You may have actively chosen to contract out via an individual plan such as a stakeholder or personal pension. Or, you may have been contracted out automatically through your workplace pension scheme – many employers, particularly in the public sector, did this as a matter of course. Either way, your national-insurance contributions record will have been affected. And because you contracted out, you may not have enough full years of contributions to qualify for the full amount of the state pension.

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The first step is to get a state pension forecast – you can do this online at the gov.uk site. If you're not on track for the full amount, despite working throughout your adult years, or receiving national-insurance credits for periods of caring, there's a good chance it's because you were contracted out for a period. You may have no memory of this – information on contracting out was often buried in the small print.

You haven't necessarily lost out. Those rebates were channelled into your private pension, which you'll be entitled to claim when you retire. The income that the rebates will generate may well be worth more than what you're missing out on from the state pension. However, that assumes you've stayed on top of your pensions. Many people have lost touch with savings they built up many years ago. It's vital that you trace every pension you've contributed to, so that you claim all the income you're owed. Facilities such as the Pension Tracing Service, also at gov.uk, can help.

It may also be possible to top up your national insurance contributions so that you qualify for the full state pension on top of your private savings. You can't top up for the years in which you were contracted out – these count as full years since you were saving elsewhere – but if you have other missing years on your national insurance record, you can replace these.

In theory, you can buy up to six years' worth of additional national insurance contributions; the cost of doing so varies according to which specific years you're buying back. Doing so could boost your state pension by several hundred pounds each year. However, topping up doesn't make sense in all circumstances – you may need financial advice to help you crunch the numbers.

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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.