AVC Pension Guide

One of the great things about running an investing blog is receiving questions from readers.

Helping out readers is not only rewarding, but it’s also an excellent source for article ideas. As an example, I recently heard from a reader whose employer offered them an AVC pension scheme, and they were wondering whether it was worth contributing to it.

The only trouble was I’d never heard of an AVC pension before.

I had to get stuck in and do some research to help answer this reader’s question – and in doing so, formed the basis of an article for anyone else who might be wondering the same thing. I seem to be on a bit of a pension binge recently, as this article ties nicely in with the other pension articles I’ve written recently, including the SSAS Pension Guide and stats on the average UK pension pots.

So here’s my guide to AVC pensions.

Contents

• What is an AVC pension?
• How much can I pay into an AVC?
• Making AVC pension withdrawals
• Who offers AVC pension schemes?
• What is a Free Standing Additional Voluntary Contribution (FSAVC) pension?
• Other types of AVC schemes
• Advantages of an AVC pension
• Disadvantages of an AVC pension
• Conclusion: Is an AVC pension worth it?

What is an AVC pension?

An Additional Voluntary Contribution (AVC) plan is an additional pension plan, set up by your employer, which runs alongside your traditional workplace pension. It allows you to make further contributions over and above whatever you’re contributing to your main workplace scheme.

In some cases, your employer may offer a matched AVC pension scheme, which is obviously a huge bonus as that’s free money for you. But it’s rare that companies offer this alongside an already-matched workplace pension scheme.

There are two main types of AVC scheme – the Defined Contribution (DC) AVC plan, and the Defined Benefit (DB) AVC plan.

The Defined Contribution (DC) AVC scheme

If your employer already offers a DC workplace pension (a DC pension is one where you make contributions to your pension out of your salary each month), then your company’s AVC plan will also be a DC plan. That means the value of your AVC pot will depend on how much you contribute, how long you invest for, and your investment performance.

The Defined Benefit (DB) AVC scheme

If your employer offers a DB workplace pension (a DB pension is one where you don’t make any contributions, but the final value of your pension is dependent on your salary and the number of years you’ve worked for your employer), then your company’s AVC plan will also be a DB plan.

These work slightly differently to the DC AVC scheme. The contributions you make into a DB AVC scheme are used to buy extra time in your employer’s defined benefit pension scheme. This can then be used to increase your DB benefits during retirement.

How much can I pay into an AVC?

As much as you want. But it’s worth remembering that you shouldn’t exceed your pension contribution limit, which applies across all your pensions. For 2022/23 this limit is set at 100% of your income, with a cap of £40,000.

Making AVC pension withdrawals

As your AVC plan is still a pension, all the usual pension rules apply. You can start drawing down your AVC from the age of 55, and are allowed to take up to 25% of your fund as a tax-free lump sum.

There isn’t a requirement to take your DC AVC benefits at the same time as your main pension scheme, so you can take the benefits at different times.

Who offers AVC pension schemes?

If you work in the public sector, there’s a pretty decent chance an AVC scheme is available to you. Teachers, NHS staff, and local government pension schemes may offer AVCs.

However, AVC schemes aren’t exclusive to public sector workers, and plenty of private sector employers offer them too.

If you don’t work for an employer who offers an AVC scheme, you may be interested in opening a Free Standing Additional Voluntary Contribution (FSAVC) pension.

What is a Free Standing Additional Voluntary Contribution (FSAVC) pension?

A FSAVC pension is similar to an AVC pension, in that it’s also a pension scheme which runs alongside your traditional workplace pension.

The difference is that you set up the FSAVC yourself, rather than your employer. You set up the FSAVC scheme by contacting the pension provider, and rather than contributions being deducted from your salary (as with workplace/AVCs), the contributions are collected from you directly.

Again, its rules are the same as traditional pension schemes, so you can start drawing down at aged 55 and take 25% as a tax-free lump sum. Similar to an AVC, you don’t need to start taking the benefits from a FSAVC at the same time as your main workplace pension, which gives it extra flexibility.

Other types of AVC schemes

So far we’ve looked at the main flavours of AVC schemes. But there are plenty of other weird and wonderful types of AVCs which employers can offer.

For example, there are ‘Added pensions’ where your contributions to your AVC go towards buying an annuity from your AVC pot.

There are also AVCs where your contributions go towards buying a tax-free lump sum at retirement.

For DB schemes, there are AVC where your contributions increase your DB earnings – for example, you might be in a scheme which builds at 1/50^th of your earnings each year, but additional contributions into your AVC increase that to 1/45^th (known as an ‘Enhanced build up’ scheme).

And there are AVCs where your contributions to your DB AVC go towards reducing the date at which you can take your full DB pension benefits (as opposed to having to reduce the level of income you’d take in retirement, which is what usually happens if you choose to take the benefits earlier). This one’s known as an ‘Earlier retirement age offset’ AVC.

This isn’t a complete list, either. If you speak to your pension provider, they’ll give you the full rundown on what’s available to you and how they work.

Advantages of an AVC pension

Being a type of pension AVC’s come with all the usual advantages of a pension:

• It helps you retire earlier.
• You receive tax relief on your contributions.
• You get free money if your employer matches contributions (although this is unlikely if they already match your main workplace pension).
• You can stop/vary the amount you pay into it.

The additional benefits of an AVC over a regular pension are:

• There might be lower administrative charges compared to opening your own SIPP.
• There’s less admin for you, as all your pensions are in one place. It’s less of a faff if your employer sorts all your pensions for you, rather than opening a SIPP and managing it yourself.
• You don’t have to start drawing down the AVC at the same time as your main workplace pension, giving you extra flexibility over simply increasing contributions to your workplace pension.

Disadvantages of an AVC pension

Being a type of pension AVC’s come with all the usual disadvantages of a pension:

• Your pension pot is locked up till you reach 55 (57 from 2028).
• There’s the obvious risk of poor investment performance.

The additional drawbacks of an AVC are:

• You’re limited by the investment options offered by your employer’s pension scheme when compared to opening your own SIPP. If your employer offers a small range of unattractive funds (think expensive active funds), then it might be worth opening a SIPP instead.
• If you change jobs, you might not be allowed to continue contributing to your AVC plan, unless your new employer offers a similar scheme you can transfer it over to.

Is an AVC pension worth it?

If you can’t invest any more into your main workplace pension scheme, and if your employer offers an AVC pension as a way to increase your pension pot, then an AVC can be a useful way to add to your pension. The stats show that pension wealth is the largest percentage of a UK household’s net worth (even ahead of property), meaning it’s the largest pot most people rely on for retirement. Given this, having the option to set up an AVC scheme to boost pension savings can only be a good thing – especially given how tax efficient saving into a pension is.

To figure out whether it’s worth opting in to your workplace AVC we need to compare it to the alternative. The most obvious alternative to setting up an AVC pension scheme would be to set up your own SIPP.

SIPP charges vary according to which platform you choose to open your SIPP with, but they can often cost over £200 per year – depending on how often you trade and the size of your portfolio. If your employer covers the cost of your AVC administration, then that’s a decent saving – especially if you have a smaller portfolio.

Ultimately, whether or not you choose to open a SIPP or go for an AVC comes down to the trade-off between fund availability and administration costs.

If your employer offers a solid range of funds to choose from, then there’s little downside to opening up an AVC and taking advantage of the likely lower administration costs compared to opening a SIPP yourself. Having both pensions in one place is likely to be a nice convenience, too.

But if your employer doesn’t offer an appealing set of funds, and you’re only contributing to your main workplace pension for the company’s matched contributions, then it might be worth opening a SIPP instead. It will likely cost you slightly more, but there are plenty of cheap SIPP providers out there, and the costs you recoup from being able to choose from cheaper funds may well offset any increase in charges.

So whether or not it’s worth opening an AVC pension depends on your company’s workplace pension fund availability, and whether you can find a cheap SIPP provider (based on your portfolio size and how often you intend to trade) with a wider range of fund options.

Either way, if you’re happy not drawing any benefit till you’re in your 50s, contributing more to your pension pots is a great idea – especially if you’re young. You’re better placed to take advantage of the incredible power of compounding, and increasing your contributions when you’re younger is far more important than the rate of return you’ll get on your investments anyway.

So it’s worth doing a bit of research into whether you should go with an AVC or a SIPP, but the main thing is to just keep investing!