The beginning of the new tax year - 6 April 2002 - marks the start of the most significant reform to state pensions for over 20 years.

The new State Second Pension (S2P) is replacing the current second tier of state retirement provision, the State Earnings Related Pension Scheme (SERPS). Virtually all employees earning £75 a week or more will be affected.

S2P is being introduced in two stages:

• Stage One will produce a greater pension than SERPS for employees with annual earnings of up to about £23,700. For higher earners, S2P will provide the same as SERPS.
• Stage Two will operate on a flat-rate basis, treating every eligible employee as if they had earnings of around £10,500 a year (in 2002/03 terms). It is likely that employees over the age of 45 will not move into stage two.

The government hasn't set a date for when stage two will begin, although it has indicated that it's introduction will depend on stakeholder pensions becoming firmly established. When it reaches maturity, S2P will be worth approximately £51 a week based on 2002/03 earnings figures. S2P will therefore be of most benefit to the lower paid.

Middle and high earners will eventually be worse off, because the stage two pension is flat rate. There is nothing new in this downgrading process, SERPS itself has been devalued on three occasions, as governments have sought to reduce pension costs. S2P is simply a further step to encourage private rather than state retirement provision.

You will be able to opt out of S2P, just as you can contract out of SERPS. The method of contracting out will be more complex than for SERPS, but there will be a mix of national insurance rebates and/or reduced contribution levels. The government hopes that all but the low paid will contact out when stage two starts, because there should be a clear financial incentive to do so.

If you are already contracted out by way of a personal pension, you should get advice before April about whether to remain contracted out for this and the next tax year. The decision is not one that can be made by rule of thumb and will depend upon your individual circumstances.