What is an AVC Pension?
Among all of the different ways you can save for your retirement is a unique kind of pension known as the AVC pension. This secondary pension is not as popular as it used to be since the reforms of 2006, but it does offer yet another option to save over and above your regular occupational pension.
The AVC acronym stands for 'additional voluntary contribution'. The name is very descriptive in explaining the key components that define how the AVC pension is structured:
- Additional – contributions made to an AVC are in addition to what you already contribute to an occupational pension
- Voluntary – investing in an AVC pension is entirely voluntary; no one can be required to do it
- Contribution – the AVC pension grows via contributions made by you, your employment, and government tax relief.
Most people who still use these pensions find them to be an easy and affordable way to top off their pension pots. These are an excellent tool for individuals who have extra disposable income or who might have delayed pension saving until after the age of 50.
Different Kinds of AVC Pensions
As with most things in the UK pension system, investing in an AVC pension begins by knowing and understanding one's choices. The first choice is between the standard or standalone AVC. A standard AVC is set up by an employer on behalf of its employees, usually through an insurance company operating a money purchase scheme. These schemes will be one of two kinds:
- Defined Contribution – A defined contribution AVC is a money purchase scheme. This means the value of your pot at retirement will be determined by how well your funds were invested. If your investments perform well, you could earn quite a return on the money you saved.
- Defined Benefit – The defined benefit AVC is a little different. Instead of contributing additional money that will be invested on your behalf, your additional voluntary contributions go to purchasing extra pensionable time. And because pensionable time partly determines your retirement benefits, you would do better with more time accrued.
Workers do not generally have a choice between these two types of AVCs when they want to save more. An employer with a defined contribution pension scheme will, by default, set up a defined contribution AVC. Likewise for an organisation with a defined-benefit pension scheme.
If you want to top up your pension through an AVC pension but are not really impressed with the scheme offered by your employer, there is one last option known as the free-standing AVC. This AVC pension is not established by the employer and is, therefore, completely disconnected with any savings you have through your workplace pension. The individual worker establishes a free-standing AVC by him/herself, usually through an insurance company.
Popularity of AVC Pensions
When the government first established that AVC pension, there were not many options for topping up the workplace pension. As such, it was harder for the pension saver to adjust to compensate for circumstantial changes without substantially affecting future pension earnings. The AVC was meant to allow savers to put away extra money when they could without any particular obligation to do so when personal budgets would not allow.
New rules in 2006 changed all of that. With the pension reforms came additional opportunities to invest in personal and stakeholder pensions. The AVC pension has not been as popular ever since. The main sticking point is that the AVC pension tends to be less aggressive in exchange for greater stability. Pension savers willing to take greater risks for higher returns tend to look elsewhere.
Because AVCs are money purchase schemes in their purest form, the investor really has to do his/her homework to make sure the best deal can be found. This is yet another reason AVC pensions are not as popular as they used to be. Finding one that offers very reasonable returns with low annual charges means doing a lot of research and asking a lot of questions. Some people find that the amount of effort required for a purchase is just not worth it. Sometimes it's better to put money into one of the other options.
Additional Contributions to the State Pension
The state pension system has its own AVC scheme of sorts to help workers make up for gaps in their National Insurance contribution record. We mention it because the government uses the same term 'additional voluntary contribution' to describe its programme. We will look at briefly here.
Almost every worker in the UK contributes to the state pension scheme through National Insurance payments. In order to be eligible to collect the state pension at retirement, the worker must have at least ten years of contributions. Unfortunately, the demise of the second state pension and the ability to opt out of it has resulted in some people with gaps in their National Insurance record. The government has set up a system of making additional contributions between now and 2017 in order to cover those gaps.
Participation in the state pension voluntary contribution scheme is subject to a strict set of qualifying guidelines. You can learn more about these guidelines by visiting the GOV.UK website.
Accessing Money in an AVC
The saver with an AVC pension enjoys the same flexibility as any other kind of pension under the new rules adopted in 2015. Any money invested can be left alone until retirement and accessed along with other pension monies, or it can be accessed as soon as the saver turns 55. Whether you wait until retirement or you begin drawing at age 55, your options are as follows:
- Lump Sum – You can take all of the money out of an AVC as a single, lump sum payment subject to income tax. This might be a good option for small pot with limited capital value.
- Drawdown – An AVC pension can be gradually drawn down through a drawdown contract established with the pension provider.
- Transfer – The saver can choose to transfer his AVC pension to another scheme that is more lucrative for better performance. However, be aware that the transfer value can be substantially less than the pot's real value.
- Combine – Some people choose to combine their AVCs with other pension plans and use the entire sum to purchase an annuity. Charges may be kept to a minimum by purchasing the annuity from the same insurance company that holds your AVC.
As for income tax liabilities, the 25/75 rule applies. The first 25% of an AVC fund can be taken tax-free. The remaining 75%, whether accessed as a lump sum or taken out gradually, is considered income in whatever year it is received. It is then taxed according to the individual's marginal rate.
Benefits of the AVC Pension
You might want to consider topping up your pension through AVC contributions if you have additional disposable income to work with. The benefits of saving for retirement in this way include the following:
- Administrative charges tend to be lower than standard pensions
- Savers can adjust contribution amounts, or stop them altogether at any time
- Tax relief applies to AVCs just as it does regular workplace pensions
- AVCs enable you to top off your pension pot without the same challenges associated with SIPPs.
Speak with the right people in your place of employment to determine whether or not your company offers an AVC. If so, and you have some extra money you want to save for retirement, this is one way to go. The company offering the AVC pension through your employer should have information explaining all of the benefits of the scheme. You can compare that information against free-standing AVCs and other options before making a decision.
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