Opting out of the state second pension The 1980s

People contracted out as they thought it would give greater benefits when retired

Back in 1988, the government started a pensions revolution by allowing people to contract out into a personal pension, rather than just through their employer's scheme. The pensions industry was keen to tell people how much better off they'd be if they took the personal pension route. By 1992, more than five million people had left SERPS for a personal pension.

Why did so many people contract out?

It was taken as given in the late 1980s that anyone in their 20s or 30s would benefit financially if they contracted out. There was an added incentive too. For the first five years of the scheme, the government paid in an extra 2% of your earnings into your personal pension if you were contracting out for the first time.

Which? analysis

Our research in late 2005 makes it clear that, contrary to expectations back in the 80s, millions of people are on course to be worse off in retirement as a result of contracting out.

Our research showed that 71% of the people in our study look likely to lose out as a result of being contracted out. That equates to around 4.5 million people. Our losers on average look set to get just 80% of the pension they'd have received if they'd stayed with the state scheme.

If you were around 35 or over when you contracted out, and so in your fifties now, the picture is even less optimistic. Of the 22 people we looked at in this age group, only one was on course to benefit from having contracted out.

Another group of losers are those who stayed contracted out after 1997. This year is important because it's when the government's incentives stopped and the rebates became 'neutral'.

What went wrong?

Personal pensions have failed to live up to the early optimistic predictions for various reasons. High policy charges, coupled with poor investment performance, have eaten into the value of these investments. And falling annuity rates mean your pension fund can buy a smaller pension income when you retire.

Were you mis-sold?

You may have been advised to contract out by a financial adviser. Whatever they're selling, advisers have a duty to make sure the policy meets your needs, and that you're aware of the risks. If this didn't happen you may have been mis-sold.

For more advice on pensions, see our book Pensions Explained, which covers state, personal and company pension funds.

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