Are AVC's worth it?

riverboat2001

I have a final salary pension, so does my partner.
He's 53, i'm 45.
As he has more years "in" than i do , i make Additional Voluntary Contributions to try and catch up with him. It would also be nice if we could both retire early together.

Basically the company sent me a form to divide up 100% between low/medium/high risk investments.

I pay an additional £104 per month into this pension scheme.


But i'm wondering whether that money is actually doing anything, would it earn more interest in an ISA.

I'm trying to be clued up on all of our monies, but i really don't understand how our pensions builds up or how the AVC's work.

mrschaucer

Some final salary schemes allow you to purchase "added years" (if you haven't got as many as OH), although this can be quite expensive. Totally different from freestanding AVCs. At least there's less potential risk for the whole lot to disappear in a stock market meltdown!

riverboat2001

Okay, i'll ask HR about it.

Starting to really think about retirement planning, sort of scary and fun at the same time...lol

dunstonh

Most AVCs are now obsolete and many companies have pulled them altogether as modern alternatives (like personal pensions, SIPPs and stakeholders as well as S&S ISAs) can offer better value for money and more flexibility. That said there is a small minority of AVCs that can be used directly in conjunction with the main scheme to have the pension commencement lump sum taken from it allowing the main scheme to pay the income. In that case, the AVC can still be worthwhile. There is an even smaller minority of cases where an employer may match AVC contributions. Free money is never to be ignored.

But i'm wondering whether that money is actually doing anything, would it earn more interest in an ISA.

Only time will tell. However, cash savings are rarely sensible for long term planning as you are replacing investment risk with shortfall risk and inflation risk. You are effectively guaranteeing a low rate of return whereas investments may give a low rate of return but could provide much more.

Loughton_Monkey

Yes, in most cases, an "AVC" is simply an arrangement to pump money (and get tax relief) into a 'money purchase' scheme to supplemement what will become available under the 'Final Salary' arrangement. As such, you could put the money into any pension scheme you chose - doesn't have to be the employer-arranged one.

But as recommended, check with your employer as to whether or not there are any 'goodies' or concessions with the AVC.

You asked about ISA. If we assume your AVC is simply a 'money purchase' scheme, then the question of whether you should use a Stocks & Shares ISA is relevant. In your particular case, it would appear that pension may be 'better', not least because of the new drawdown rules - for which you will probably comply if your Final Salary pension is going to give you £20K or more (including state pension).

To understand this, think about 'investing' spare cash to be available on or around retirement age. Here are 2 choices:

1. For an ISA, you are simply putting in taxed income. It will grow (hopefully) according to the growth of chosen funds (less charges) and at any time, any age, that cash is available in whole or in part to spend exactly as you wish when you wish. Totally flexible.

2. For a pension, consider that the underlying funds can be almost exactly 'clones' of the same funds in your ISA, and so will grow at a very similar rate. However, for every £80 you put in, HMRC are effectively 'riding on your back' and throwing another £20 into the same investment. If you then take the resulting fund 100% as pension, HMRC will take back all of its £20 (plus growth) by means of basic rate tax as and when the pension is paid. In which case the pension will 'mirror' the ISA financially exactly the same, but with limitations on the speed with which you draw it. HOWEVER, when you take the tax free 25% lump sum, you are, in effect, 'gaining' because you are not only taking 25% of your own funds tax free, but those of HMRC as well.

Notably, though, because of the new drawdown rules, such a pension fund can be leveraged (a) by taking the 25% tax free, and (b) putting it into 'drawdown', which makes it 'almost' as flexible as an ISA fund because you can draw it down as you please - all of it in one year if you want (although if that put you into higher rate tax, you probably wouldn't).

In summary, there are several people to whom an ISA might be a better bet than a pension, basically because of the flexibility. Those, however, with a 'secured' pension (such as a Final Salary scheme) will find that saving in a pension provides a distinct 'edge' due to the 25% tax free lump sum, combined with the new rules making it almost as flexible as an ISA fund would be. Any IFA should confirm this. [Additionally, the pension route also, obviously, gives you the 'annuity' option which does have the benefit of 'underwriting' longevity - something an ISA or drawdown arrangement doesn't do].