FOOL'S EYE VIEW
AVCs: Sense or Nonsense?

By Alan Oscroft
June 26, 2001

Virgin Rail West Coast Line -- Does your employer contribute any money to your company pension scheme? If so, you are part of an ever-diminishing group of people. Whether such a scheme is in general a good idea is open to question, because it is the entire job package that matters (getting more actual cash rather than pension contributions, for example, is a pretty good alternative). But if you have a company pension, can you make better use of it through additional voluntary contributions (AVCs)?

Many company pension schemes work by your employer matching your pension contributions, pound for pound, up to a specified maximum (often expressed as a maximum percentage of your basic salary). Suppose your employer's maximum contribution is 3% of your salary and you are earning £22,000 per year (which is around the average UK salary). That means that your employer will match your pension contributions up to a maximum of £660 per year. So if you put in £660 per year, they'll put in £660 per year, which is no bad thing.

Other schemes will work differently, but the important figures to unravel are the maximum amount your employer will contribute, and how much you need to contribute yourself in order to get it.

If you are fortunate enough to be part of such a scheme, it usually makes sense to ensure that your pension contributions at least match that level to get the most from your employer. But should you contribute extra? And if so, how much?

AVCs

Additional voluntary contributions can be made through company pension schemes. They allow you to contribute a larger slice of your salary to your pension (up to that maximum allowed by regulation) in order to increase the size of your retirement pot. AVCs made though employee schemes enjoy economies of scale too, and so the charges can often come in lower than doing it yourself.

FSAVCs

In addition to company sponsored AVCs, many pensions companies also offer Free Standing AVCs (FSAVCs), and you can use these to build up the level of your contributions, providing your total contributions don't exceed the maximum allowed. Sound like a good idea? Beware, because FSAVCs can cost you a great deal of money in charges.

During the infamous pensions mis-selling scandal, many people fell victim to a particularly unpleasant conflict of interest. After consulting financial advisers, the victims were advised not to use their company AVC scheme, but instead to put their extra money into private FSAVCs. In many cases, the recommended FSAVCs were pretty much identical to company AVCs, with one exception: they charged more in order to cover the cover the fat commission paid to the "adviser". Such mis-selling is currently being investigated by the Financial Services Authority (FSA).

How Much?

FSAVCs can suffer from the same charging problems that have plagued many personal pension schemes. Just as with endowments of old, you can end up paying the lion's share of your first couple of years' contributions in charges. And a couple of years down the line if you decide you need to increase your contributions, the punitive charging scheme can start again, with another few years of hefty sums to cough up. In some cases, around 25% or more of your total contributions can end up in the pension company's pocket rather than contributing to your retirement.

So What Are The Options?

What do you do, then, if you want to top up your company pension? If your employer offers an AVC scheme, you can expect to get a better deal on charges than if you did it yourself with FSAVCs. FSAVCs, at least at the moment, appear to offer a relatively poor investment.

If you increase your contributions beyond the limit of any employer contributions though, you need to be aware that the extra you are buying will most likely suffer from the two bugbears of pension schemes in general: relatively poor returns and the obligation to eventually buy an annuity. On the other hand, you do have the possible tax benefits of getting tax relief at a higher rate on your contributions when you're working and paying at a lower rate after you retire. And your money is protected from any urges you might get to spend it, which can be a big plus for a lot of people.

One alternative to using AVCs to top up your pension is to take out a stakeholder pension in addition to your company pension scheme. More on stakeholder pensions can be found at the Motley Fool's Pension Centre.

Or instead of putting money into a pension scheme, many people opt for putting the extra money they wish to invest into an alternative  investment vehicle like an ISA. The debate over Pension versus ISA is an interesting one, and the swings and roundabouts are dealt with in some detail in this recent Duelling Fools.

Whichever way you choose to go about it, making sure you'll have a big enough retirement pot should be something of a priority for everyone. So think about topping up your pension investments, though not necessarily using AVCs.

More

The Fool's Pensions Centre

For a much more in-depth look at pensions and the alternatives available to you, the latest Motley Fool Book, "The Old Fool's Retirement Guide" is great first investment. You can get a copy here.
Next month, July, is retirement month at the Fool, so stay tuned for special reports.