RPSM02403010 - Employer Pages: Registering a pension scheme with HMRC: Contracting out of the state second pension scheme on or after 6 April 2006: What does "contracting out" mean?
The state pension consists of two elements, the basic state pension and the additional state pension, currently known as the state second pension. This additional pension, broadly speaking, pays benefits at a level determined by the earnings level of the employee in question.
It is possible for a private pension scheme to take the responsibility from the state for providing the additional state pension. It can do this for some or all of its members. This is known as "contracting out". On reaching state pension age, the scheme member will receive his/her basic state pension from the Department for Work and Pensions, and the additional state pension from the contracted out private scheme.
A pension scheme can be set up purely to contract out and accept no other contributions.
Alternatively, a pension scheme can be set up to provide both pension benefits funded by employer and/or employee contributions as well as the additional state pension element, if it contracts out.
Only employees may be contracted out. Self-employed workers are not part of the state second pension system.