DP Money: What a state we are in...; Jane Hall reports. State second pension -in or out? More importantly, do you actually understand how it works?

Byline: Jane Hall

GEING has always been an issue. But it's not grey hair, wrinkles and a thickening girth which are occupying many people's thoughts at the moment. It's whether they will have enough money to sustain them in their twilight years.

Pensions -or lack of them -are top of the news agenda. The roller coaster ride the stock market has been on recently has adversely hit any linked investments and this, coupled with some occupational pension schemes being wound up, misselling scandals and the possibility of the retirement age being raised to 70, have left millions wondering if,after years of squirreling away for their old age,all they have left to look forward to is a poverty-stricken future.

But while the talk around the nation's dinner tables has been of whether there will have to be a tightening of the proverbial financial belt in later years, it's a sure bet there has been little discussion about the merits of opting in or out of the Government's state second pension, the trendily-branded S2P. That's if anyone has heard of it. There is a story doing the rounds, no doubt an urban myth but nonetheless entertaining, of one man when told he should check out his S2P position booking an appointment at his localmedicalcentre.

But while S2P isn't a communicable disease,it is something which will grow unnoticed and will affect the quality of your life in later years. And it is something that Norman English, a partner with independent financial advisers Wade Associates, says 90pc of people should be making every effort to get, for it can have a very real effect on the amount of income you will be left with when you retire.

S2P was introduced in April last year and replaced the StateEarnings Related Pension Scheme (Serps) as a top-up to a basic state pension.

People on lower incomes receive more money in their pension pot under S2P, and those who a reentitled to Invalid Care Allowance, look after an ill or disabled person or take care of a child under six, are also allocated contributions by the Government.

All employees who pay National Insurance Contributions (NICs) are automatically included in S2P. If you remain in the scheme throughout your working life, you will eventually be entitled to a pension equivalent to 20pc of your average lifetime earnings.

The alternative is to ``contract out'' of S2P. This means you will receive a rebate of part of your NICs straight into the personal or occupational scheme of your choice.

FOR each year you are contracted out of S2P, your state pension will decrease that bit more.

Since the 1980s, the Government has been keen to encourage people to build their own private pension provision rather than relying on state benefits and to contract out of what was then Serps.

It was assumed that the investment returns generated by people's NIC rebates would outstrip the state pension payments they would have lost by leaving Serps.

But rising annuity costs,falling investment returns and increasing taxation means NIC rebates are no longer sufficient to compensate people for giving up their Serps and S2Pbenefits.

Severallarge insurers, including Royal& Sun Alliance, Prudential, Ax a and Legal & General, have written to policyholders urging them to contract back into the S2P.

Axa claims people who remain opted out of the S2P will end up with about a seventh less income in retirement.

It has estimated that a 30-year- old man who had contracted out would receive around 14pc less income when he retired than if he had remained in S2P.

Steve Folkard,head of pensions marketing at Axa, says: ``Our analysis of the level of rebates suggests that,at current levels,no-one should contract out.'' Axais now calling on the Government to increase NI rebates for the current tax year,or face the prospect of people contracting back into the S2P scheme in huge numbers -a campaign it says is backed by 78pcof independent financial advisers. ORMAN English is in no doubt that contracting back in is currently the best way forward. ``As everyone knows, state pensions have altered an awful lot over recent years. When Serps was first introduced it was estimated there were 35 employed people to support every retired person. But by 1988 this had been revised to six to one, and this is why the Government launched a massive, and highly successful campaign, to get people to opt out. By doing so the Government's liability dropped. In other words, they could savemoney.

``Employees were originally encouraged to contract out with generous financial incentives paid on top of their NI rebates. These have all but disappeared and moreover, the introduction of age related rebates in 1997 has now eroded the incentive for younger employees to opt out. ``Previously, it was advised that all workers below the pivotal age of 45-50 for males and 40-45 for females should contract out ofSerps.''

Mr English continues: `` When people were first encouraged to contract out, the rebates were sufficient to match or exceed Serps with little investment risk. But the assumptions that the Government actuary is now using mean you can no longer expect to get a better return by contracting out of Serps,or S2Pas it now is, without taking a substantial investment risk.

``All the calculations we have done show that 90pc of people should be contracting backin.''

Which is why Wade Associates is launching its own campaign to encourage people to take a serious look at their pension provision -and find out what their S2P position is. To this end, the firm has produced its own free guide to state pension benefits.

Topics covered include the S2P and how to contract back into it. Mr English says: ``It is very easy to get backin, it just requires the filling in of a couple of documents. But it's not something the Government likes to advertise so many people don't know how to go about it.''

Your final S2Pentitlement will be calculated by looking at the proportion of time your were in the scheme between the age of 16 and retirement. Selfemployed people don't qualify for S2P,or for contracted-out rebates. But they are rewarded by paying lower NI rates.

MAKING the decision on whether you should contract in or out is not easy, which is why Mr English says everyone should seek independent financial advice,and regularly review their pension strategy.

At the end of the day, however, it comes down to whom you trust more: the Government or the insurance company.

Although government rebates are now lower than they were, the advantage of contracting out is that the rebates can be invested, and may potentially make more money than in the scheme. The risk is that markets may perform badly,and leave you even worse off.

Furthermore, there is always the possibility,however remote, that your pension provider could go bust.

The major risk of remaining contracted in is that there is no real certainty that the Government will deliver on its promises. For those who are not set to retire for a long time, there is a chance that future governments may overhaul the pension system and water down, or even scrap,S2P.

The pension offered under Serps was worth 25pc of the average of the best 20 years' earnings. This has already been changed under S2P to just 20pcof average lifetime earnings. So that will include the year you worked pulling pints for pounds 3 an hour when you were 19.

The other downside with S2Pis that,as a state pension, you can't get your hands on it until the state retirement age -currently 60 for women and 65 for men.

But most pension providers are unofficially leaning towards contracting back in. Earlier this year,HSBC took the bull by the horns and wrote to all 47,000 of its personal pension plan holders telling then they would automatically be contracted back in unless they explicitly requested to stay opted out.

ARPAL Karlcut,head of pensions for HSBC, says: ``On the Government's own assumption, there is very little financial benefit from contracting out,but the risks are significant.''

As well as smaller rebates,investment returns are also likely to remain lower over the coming years. Furthermore, people will get less for their money when they are forced to buy an annuity with their personal pension. Under the state scheme, there is no need for annuities, with regular payments guaranteed from retirement until death.

Norman English dismisses fears that the Government will eventually renege on its promise to deliver state pensions. ``I believe there will be something here in 20 or 30 years' time,'' he says. ``But with the pensions landscape undergoing constant change, it is well worth reviewing your decision to contract in or out of S2P annually. Thousands of investors who decided to contract out years ago have never reconsidered their decision.''

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AGE CONCERN: You may not yet have one foot in the grave but your future finances should be double-checked