Should I be saving up AVCs?
You need to work out how much your pension is worth and weigh up the costs, risks and rewards
Q
HERE’S my scenario: I’m 60 in January 2022, work for an IT company and have been paying into a defined benefit pension fund for the last 27 years. Already there is a shortfall. I am hoping to retire at 65. My question is: would it be worth topping up my pension for the next five years with an AVC? If I were to put £300 a month for the next five years into a Additional Voluntary Contribution (AVC) would this be worth it? I know this only means £18000 in five years but what would be the benefits on doing this? Are there any downsides to doing this, and would I see much difference in payout from my pension when I decide to take it in about five years’ time? Steve Oswald
A
I BUMPED into a regular reader of these pages last week and he asked me why so many of the questions I answer are to do with pensions. The simple answer is contained perfectly in Steve’s question, and it is that so many of us are confused about the best way to plan for our retirement when it comes.
Pensions are perceived as being really complicated. The rules seem to change all the time and there is an interaction between personal pensions, occupational pensions and the state pension that is not always easy to follow.
The way Steve framed his questions doesn’t make it easy to answer – and this is in not a criticism. It’s a perfect example of the situation I described above, which is that I answer so many question about pensions because readers ask me so many questions. Steve haven’t given many details about his current or previous employments so some of my comments my sound a bit vague.
So Steve, if you want to drop me another line with a detailed employment and income history I might be able to give you a more specific answer. The main difference between the benefits you would build up in an AVC and those you build up in Defined Benefit Pension Fund (DB) is that the former are likely to have no guarantees.
The money you pay into the AVC is invested and, as you say would
total £18000 over five years if you invest £300 per month. In five years’ time, that £18,000 might have grown to £30,000, it might have fallen to £10,000 or it might still be worth £18,000.
There is an element of risk that sits on your shoulders and you don’t have much control over, apart from the fact you can choose the level of risk you take by the funds you choose to invest it.
The money you pay into the AVC will generally be eligible for tax relief at your marginal rate of tax so if you pay tax at 41 per cent every £1000, you invest will only cost you £590 or so. That’s a great benefit. If you pay £300 a month into an ISA instead of an AVC, it will cost you £300. If you pay £300 a month into your AVC, it might only cost you £177 or so depending on your tax rate.
But maybe you need to go back a bit and look at what it is you want to have when you get to 65, which is your intended retirement date.
You need to look at all of the pension provision you have and figure out how much it will all be worth at 65, and what options you have with your main pension as far as tax-free lumps sums and taxable pension income are concerned.
Some schemes, for example, might allow you to increase the level of tax-free cash you can take at retirement if you reduce your annual pension. This could mean that in some situations you would effectively be able to take all of your AVC out as cash, although this is dependent on scheme rules.
If you find your current pensions are projected to give you as much money as you think you will need at retirement then perhaps you don’t need to do anything else at all from a pension point of view with your £300 per month.
Perhaps you might be able to save it in an ISA and have a nice tax-free lump sum to do something with when you get to retirement age.