AVC scenario

malcolmfowler

Regarding the normally sound advice to pay off debts before saving, I have the following scenario.

I am just 50 and in a company pension scheme. I also save 7% of my salary into an AVC fund. The company pension rules allow me to take all of my AVC’s fund as a tax free lump sum when I retire. I am a 40% tax payer. I plan to retire at 55.

The company AVC fund is equity biased and is currently returning 10.1 % per annum made up of a guaranteed amount of 5% and a bonus element of 5.1%

I have recently borrowed £10,000 from the building society, which I no longer need and plan to pay back. It is an interest only loan costing me 6% to service.

This is my question.

If, instead of paying the £10,000 back to the building society, I put it into my AVC fund, would this happen.

£10,000 added to the AVC fund
£ 4,000 claimed back from the tax man

---

£14,000 total

Assume AVC’s grow at 10%

Year 1 interest added £15,400
Year 2 interest added £16,940
Year 3 interest added £18,634
Year 4 interest added £20,497
Year 5 interest added £22,547

Total after 5 years £22, 547

Deduct 5 years interest payments on loan and pay off loan (£13,000)

Total in hand £9,547

Is this a feasibility way of using equity from the house to build a nest egg?

jonathon_hart

Not quite.

As it is a company pension you would invest the £10,000 in your pension and then would need to reclaim to £4,000 tax from the tax man yourself this will then get paid to you (probably through an adjusted tax code) not invested in your pension.

Do remember that on retirement you can only claim 25% of your total pension pot as tax free cash and the rest is generally used to buy an annuity or income for life. There are other alternatives like draw down which others will be able to give you more information on.

Is the loan secured on your house? If so is there any possibility of you having problems paying it back if you were to get ill or redundant etc? From 6 April 2010 you will not be able to access your pension funds until 55 so for those approximately 3 years between 6 April 2010 and your 55th birthday in 2013 you will not be able to access the pension unless you were very ill and could claim ill health retirement.

jonathon_hart

just seen your comment about all the AVC as Tax free cash - this is generally true but the total Tax free cash cannot be more than 25% of your total pension pot - so if you had a lot of AVCs then you might not be able to.

malcolmfowler

OK, thanks, I see your point.

If however, I paid off the 10K and used 10k from my own savings and paid this into my AVC fund , and then paid in the amount I got in tax relief also into my AVC fund, were my assumptions correct?

i.e. 10K added to my AVC pot would grow by another 40% in year 1 (tax relief), plus the 10% each year from the AVC fund. If I'm happy to tie this up for 5 years I get an excellent deal.

jonathon_hart

malcolmfowler wrote: »

£14,000 total

Assume AVC’s grow at 10%

Year 1 interest added £15,400
Year 2 interest added £16,940
Year 3 interest added £18,634
Year 4 interest added £20,497
Year 5 interest added £22,547

Total after 5 years £22, 547

Deduct 5 years interest payments on loan and pay off loan (£13,000)

Total in hand £9,547

Your figures there look correct to me based on your assumptions in terms of the growth of the fund and total needed to pay off the loan and that you will have £10,000 of taxable earnings in the 40% tax band during this tax year and you can access the amount as a lump sum on retirement.

nicko33

malcolmfowler wrote: »

If, instead of paying the £10,000 back to the building society, I put it into my AVC fund, would this happen.

£10,000 added to the AVC fund
£ 4,000 claimed back from the tax man

---

£14,000 total

Assume AVC’s grow at 10%

Year 1 interest added £15,400
Year 2 interest added £16,940

Don't you reclaim £6,666.66 from the taxman? (£10,000 / 0.6 ) - £10,000 [ or 2/3 of £10000]

i.e to be left with £10,000, you originally had £16,666 and were taxed at 40%
40% of £16,666.66 is £6666.66

and then if you put that £6,666 in the AVC also
can you reclaim £6,666 * 2/3 = £4,444

and if you put that £4444 in the AVC.......
and if you sum the series you end up at £30,000

which sounds silly, so where is the flaw?

jonathon_hart

£6,666.66 does sound right thinking about it... I always fall for that one!

None in theory as long as you had enough income taxed at 40%. If you only had £10,000 income taxed at 40% in that tax year then you can only claim tax back at the 40% rate on £6,000.

In addition I believe they generally do it via adjusting your tax code so it would take you a long time to have that much to invest (probably several years) or to recoup the money back if you used savings.

jonathon_hart

jonathon_hart wrote: »

None in theory as long as you had enough income taxed at 40%.

And are prepared to/ can afford to invest £30,000 in AVCs into the pension plan of course... It still £30,000 of your money that you have paid in - you have not created yourself a profit here because it is your money you have paid in that you would have been taxed on when you received the money (think about it!!)