Spirit of Serps is back to haunt our pension plans

Melanie Bien finds the great contracting-out debate still raging

Pensions are complicated beasts at the best of times but when it comes to the state second pension (S2P), and whether or not you should "contract out", they take on a whole new level of difficulty. Even the experts can't decide on how to advise consumers - as demonstrated by the row that erupted last week between the industry and a consumer group over what information and help we should be given.

Pensions are complicated beasts at the best of times but when it comes to the state second pension (S2P), and whether or not you should "contract out", they take on a whole new level of difficulty. Even the experts can't decide on how to advise consumers - as demonstrated by the row that erupted last week between the industry and a consumer group over what information and help we should be given.

The row was sparked by the publication of a free consumer factsheet by the Association of British Insurers, the industry body. The factsheet explains what S2P is, what contracting out involves and how to decide whether you should actually do so. It lists the pros and cons of contracting out and contracting back in, with the aim of enabling consumers to come to their own decisions.

But Teresa Fritz, the principal researcher for Which?, the magazine of the Consumers' Association, slates the guidelines for "lacking in real guidance".

"Contracting out of the state second pension is a terribly complex subject and we are shocked that the industry - after collecting commissions for years - has produced a factsheet so lacking in any real guidance that it leaves people completely in the dark about what to do next to secure their pension," she says.

The decision to contract out of S2P (which replaced the State Earnings Related Pension Scheme, or Serps, in April 2002) is supposed to be down to the individual, depending on their age, their attitude to risk and how they think the stock market is going to perform.

In 1988, the Conservative government under the then chancellor, Nigel Lawson, started advising people to opt out of the additional state pension scheme and take out a private personal pension instead. The idea was that a private pension could generate a bigger pension than the state scheme. Then, as you neared retirement and were therefore less willing to take on stock market risk, you would contract back in, reducing your exposure.

If you contract out, the government makes payments to your private pension - whether it is an occupational, personal or stakeholder scheme - in return for your relinquishing of rights to S2P. If you don't contract out, you pay extra national insurance contributions to build up your entitlement to receive S2P beside the basic state pension in retirement.

While contracting out used to be the norm among young people with private pension provision, some advisers have changed their view, recommending that policyholders don't contract out of S2P because the rebates for doing so aren't high enough.

Last year, HSBC went as far as to contract back in all its pension customers, saying it was no longer in their interests to remain contracted out.

Which? is calling for advisers and providers who advised customers to contract out in the past to offer free advice on whether they should be contracting back in. It recommends that customers go back to the original firm or financial adviser and demand help in making the right decision on a complex issue.

"The wrong decision means some people may be heading for a pension worth 60 per cent less than they would have received if they hadn't opted out of the state scheme," adds Ms Fritz.

But whether these advisers will actually be prepared to put their necks on the line and give the advice their clients need is another matter. "We can't recommend that clients take a particular course of action," warns John Turton, director for life and pensions at independent financial adviser (IFA) Bestinvest. "It all comes down to your belief in the performance of the market. We can't guarantee rates [so the decision to contract back in or stay out] is too tight to call."

Tom McPhail, pensions research manager at IFA Hargreaves Lansdown, agrees.

"This is not a problem of the industry's making," he says. "The Government has put us in an impossible position and the industry is falling over itself to be seen to be doing the right thing."

Even though it makes sense for the majority of people to contract back in again, he isn't planning to switch his own pension: "I am remaining contracted out so the money is where I can see it, but that is a personal decision."

Bestinvest will continue to offer clients not advice but "commentary".

"We are not saying everyone should contract back in to S2P or contract out - each case is decided on its own merits," adds Mr Turton.