Should we make a backup of our entire 7 system and then remove contribs before backing up for transfer to 8?
Since this process is not tested by the dev team you are on your own. My advice is to always backup.
Since there is no release candidate at the moment, contrib authors have not had the time to test/update their contribs so nothing can be said about that. At the moment it is of no use (at least to the dev team) to try the upgrade from SME Server 7 to SME Server 8, but if you were to do so I would try it only from a fresh SME Server 7 server without contribs to a fresh SME Server 8 without contribs.
My advice is to only test SME Server 8 when you are very familiar with the product, prepared to report bugs and do proper follow-up in trying to help the dev team tackle the problems. And finally only install it on a spare machine and straight from the SME Server 8 installation CD. Do not use it as a production machine!