AVC Pensions: How Additional Voluntary Contributions Work
An AVC pension scheme could prove useful if you want to supplement payments you make into a workplace pension. AVC pensions allow flexibility when it comes to managing contributions and can help boost your future retirement benefits.
An AVC pension – where AVC stands for additional voluntary contributions – is a scheme that an employer can set up to allow employees to add funds in addition to the pension savings that can be paid into a main workplace pension. By making extra contributions into an AVC pension, you’ll give yourself a better chance of enjoying more generous pension benefits when the time comes for you to retire. Read on to find out more about how an AVC pension works, the pros and cons of making additional voluntary contributions, and what free standing AVCs are.
What is an AVC pension?
Auto-enrolment means employers are now obliged to offer a workplace pension to eligible workers. However, to help employees who want to contribute more and top up their pension so that they can build up extra pension benefits, an employer can set up an AVC pension to run alongside the main scheme which will accept further contributions.
» MORE: Learn about workplace pensions
How do pension AVCs work?
Depending on how the main pension scheme operates, an AVC pension can take the form of a:
Defined contribution AVC pension
In line with any defined contribution scheme, the payments you make into your AVC will be invested, with the eventual size of your AVC pension fund depending on how much you put in and the performance of your investments. Once you start taking benefits from the main scheme – typically anytime from age 55 – you’ll normally have the option to access your AVC fund, and take an income from there too. However, there isn’t usually an obligation to take them at the same time.
Defined benefit AVC pension
With a defined benefit scheme, the main difference is that the income you receive when retiring is determined by your salary and length of service with your employer. As a result, any money put into an AVC attached to a defined benefit pension will be used to secure ‘added years’ of service, which in turn enhances the benefits provided at retirement. The necessary connection with the main scheme to determine the overall qualifying years means benefits here must be taken simultaneously.
Features of AVCs
There are various features of additional voluntary contributions in relation to contributing towards and accessing your AVC benefits that can make AVCs attractive to prospective pension savers.
Making AVC contributions
If you wish to contribute to an AVC pension, your employer will arrange for the payments to be taken from your salary and directed to the AVC scheme before it’s paid to you.
How much you pay is up to you. You will receive tax relief provided you stay within your pension contribution limit - for the 2021/22 tax year, this annual allowance is the lower of your annual earnings or £40,000. AVCs are flexible so it should be possible to make ad hoc payments into an AVC or set up regular payments and vary the amounts whenever you want.
AVC pension tax relief
The contributions you make into an AVC pension can qualify for pension tax relief if they are within your annual allowance. For basic rate taxpayers, relief is paid at 20% – this means an overall payment of £100 into your pension will cost you £80. Higher-rate taxpayers get relief at 40%, and additional-rate taxpayers at 45%.
» MORE: Pension tax relief explained
Making AVC pension withdrawals
Normally you can start taking benefits from your AVC pension from the age of 55, even if you want to continue working (note that this age is rising to 57 in 2028). However, the type of AVC scheme you have, and any rules specific to it, will determine exactly what you can do.
With a defined contribution AVC you’ll be allowed to take up to 25% of your fund as a tax-free lump sum. For whatever remains, you then usually have the choice of purchasing a pension annuity, entering into income drawdown, withdrawing everything as a lump sum (albeit with significant tax penalties being likely) or a combination of the above. There isn’t usually a requirement to take defined contribution AVC benefits at the same time as your main scheme.
With a defined benefit AVC, however, as contributions are used to buy added years’ service, these must be included when you take your main scheme benefits. It’s always best to check with your employer exactly what the rules are surrounding an AVC scheme and its relation to a main scheme.
What are free standing additional voluntary contributions (FSAVCs)?
If your employer doesn’t offer an AVC pension, it’s possible to set up a free standing AVC scheme – or FSAVC – to sit alongside a main pension scheme. What is different with an FSAVC is that you arrange the plan yourself with a pension provider, and the contributions come directly from you, rather than being deducted from your salary.
Are AVCs worth it?
Whether an AVC or FSAVC is a good idea depends very much on your circumstances, the pension provision you already have, and the makeup of the AVC scheme.
Advantages of AVC pensions
- It should help you towards securing additional benefits for a better retirement.
- It could be cheaper than taking out an entirely separate personal pension.
- You have the flexibility to stop, start and amend contribution amounts when you want.
- Pension tax relief on qualifying contributions will boost your pension further.
Disadvantages of AVC pensions
- Funds in an AVC usually can’t be accessed until you’ve started taking benefits from the main scheme.
- If you change jobs, you might not be allowed to continue contributing to your AVC, unless your new employer offers a similar scheme that you can transfer it over to.
- An AVC plan arranged by an employer may not offer all the benefits and flexibility that you could find in a private pension of your own choosing.
» COMPARE: Personal pensions
Who offers AVC pension schemes?
If you work in the public sector in certain fields, Teachers’ Pensions AVCs, NHS Pension AVCs and Local Government Pension Scheme AVCs may be available to you. Details should be provided by your employer. However, AVCs are not exclusive to public sector workers and many private sector employers offer them too.
To take out an FSAVC for yourself, you’ll need to approach a pension provider or insurance company.
Are there alternatives to an AVC pension?
If your employer doesn’t offer an AVC pension, or an AVC or FSAVC isn’t right for you, there are a number of pension options that you could consider as an alternative. These include personal pensions and self invested personal pensions (SIPPs), although if you’re unsure, getting pension advice is always a good idea.
» COMPARE: SIPPs
WARNING: We cannot tell you if any form of investing is right for you. Depending on your choice of investment your capital can be at risk and you may get back less than originally paid in.
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Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more