Additional Voluntary Contributions (AVC) in the UK

Additional Voluntary Contributions (AVC) | March 2024

Additional Voluntary Contributions, or AVCs, are payments made in addition to your regular pension contributions.

Made to your company pension scheme, these extra contributions can help to increase your income for retirement. AVCs can be a smart financial move, as offering potential tax relief and easing financial stress for your retirement.

Table of Contents

Understanding Additional Voluntary Contributions

Additional Voluntary Contributions is a top up pension which you make into your fund, beyond your normal pension contributions. This financial decision can help you to feel more secure about your retirement income, investing more money into your later life by contributing extra. This can be beneficial for your retirement, as the more you invest, the more potential there is for your pension savings to grow. 

It is important to note that according to data from the Office for National Statistics, the average pension wealth for people aged 55-64 in Great Britain was £253,000 in 2020/21. Therefore, this further emphasises the necessity of boosting retirement savings through options like AVCs.

Your pension provider holds The AVCs you make within your company pension scheme. Depending on your employer’s arrangements, this may be an insurance company, a building society, or another type of pension provider. This AVC money is invested to grow your pension fund. The types of investments available for your AVCs are dependent upon the specific AVC scheme your employer has set up.

Making AVCs is not a decision taken lightly. It’s important to weigh up all your options and consider your financial situation. You may choose to seek professional financial advice, ensuring that making AVCs is the right move for you in your personal financial situation. They can provide you with knowledgeable information about the process which will help you to make an informed decision. Keep in mind that whilst AVCs offer the potential for greater retirement income, they also come with the risk of low performing investments.

One key thing to understand about AVCs is that they are different from standing additional voluntary contributions (SAVCs). Whilst AVCs are made to your employer’s pension scheme, SAVCs are made to a separate pension scheme set up by an insurance company or another pension provider. 

The Process of Making AVCs

Making additional voluntary contributions to your pension pot is relatively straightforward. First, you must decide how much you want to additionally contribute. Typically, this is a percentage of your salary, or occasionally a set amount. Your employer will then begin paying these contributions from your earnings into your AVC fund.

Once you’ve set up your AVCs, you can choose to stop or change your contributions whenever you like. You may also be able to restart paying AVCs after you stop, depending on your scheme’s rules.

Tax Implications of AVCs in the UK

One of the key benefits of making AVCs is that the money you contribute as AVCs is deducted from your earnings before you pay tax. This can reduce your overall tax bill, making AVCs a tax-efficient way to save money for retirement. Furthermore, when you begin taking money from your pension after retirement, up to 25% of your pension fund (including AVCs) can be taken as a tax-free lump sum.

However, there are certain limits on how much you can contribute as AVCs and still receive tax relief. According to UK Government legislation, the Pensions Regulator and the HM Revenue and Customs, the current tax relief on pension contributions is up to 100% of your earnings, or £40,000 per year. This depends on whichever is lower. To avoid unnecessary tax payments,It’s important to keep these limits in mind when deciding how much to contribute as AVCs. This is because you won’t receive tax relief on the excess if you contribute more than this.

When you begin taking money from your pension, any income you receive over your tax-free lump sum is subject to income tax, including AVCs. The amount of tax you’ll pay will depend on both your total income in retirement and your tax bracket.

The tax implications of AVCs can be complex, so it’s a good idea to get advice from a financial advisor or a pensions expert, helping you to understand the potential tax implications of making AVCs. They can also offer advice on the best course of action for your personal circumstances.

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Benefits and Drawbacks of AVCs

There are several benefits to making AVCs. Firstly, as previously mentioned, they offer a tax-efficient way to save for retirement. The tax relief you receive on your contributions, and the ability to take a tax-free lump sum, can make AVCs an attractive option. 

Secondly, AVCs can help to increase your retirement income. You’re investing more money for your later life by making additional contributions to your pension, providing you with a larger pension fund for your retirement.

Thirdly, AVCs can provide extra life cover. Some AVC schemes offer life insurance as part of their package. This means that if you pass away and still have some money in your fund, financial security can be provided for your loved ones.

On the other hand, there are also some cons to putting money into AVCs. One of the main drawbacks is that the performance of your AVC investments are tied to the stock market. Therefore, if your investments don’t perform well, you could end up with less than you contributed.

Another drawback is that AVCs are not very flexible as once you’ve made contributions, you can’t usually access your money until you retire. This makes it risky if you fall into financial struggle.

Finally, although the tax benefits of AVCs give great relief, they are subject to certain limits. You won’t receive tax relief if you contribute more than the annual limit. It’s also important to recognise that any income which you receive from your AVCs (beyond the initial lump sum) is subject to income tax. 

"When planning for retirement, it's important to consider all options for saving money, with AVCs being just one of these"

Choosing Between AVCs and Other Pension Options

When planning for retirement, it’s important to consider all options for saving money, with AVCs being just one of these. Other options include increasing your contributions to your main pension scheme, investing in a personal pension, or saving through an Individual Savings Account (ISA).

Other pension options, such as personal pensions and ISAs, also offer the tax advantages of AVCs. It’s important to compare the different options, considering what’s best for your circumstances. If you’re unsure about the best course of action, seeking out financial advice is advisable. 

It’s also important to consider the risks associated with each option. While AVCs offer the potential for higher returns, they also come with high risk associated with the performance of investments. It is crucial to remember that the value of your AVC fund may go down, as well as up, at any stage.

AVCs can be a great way to boost your pension pot. However, it’s important to consider all options before deciding as they’re not suitable for everyone.

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AVC Pension and Defined Benefit AVC

An AVC pension is a type of defined benefit AVC where additional voluntary contributions (AVCs) are made alongside your normal contributions to your workplace pension. The AVC pension operates within your main scheme, and your employer setting plays a crucial role in determining the specific rules and benefits. 

Alternatively, defined benefit AVCs are linked with defined benefit pension schemes, where your pension income is based on your salary and length of service. Creating AVCs in a defined benefit scheme can increase your retirement income, giving you a larger pension pot in retirement. However, the benefits received from your AVCs will depend on several factors, including the performance of your AVC investments (depending on the stock market) and the rules of your AVC scheme outlined by your employer.

Under a defined benefit AVC plan, your additional contributions are invested to provide you with returns in the form of additional income (or a lump sum) when you retire. This is managed by your AVC provider, often your employer or a third-party pension provider. 

However, AVCs in a defined benefit scheme often contain certain restrictions. For example, you may not be able to take your AVC benefits simultaneously with your main scheme benefits. You may also have multiple options for taking your AVC benefits, such as a tax-free lump sum or extra pension income.

Workplace Pension and Shared Cost AVC

Your workplace pension is the main pension scheme provided by your employer, and it includes your normal contributions and any AVCs you make. These payments sit alongside your workplace pension, serving to top up your pension benefits. Employers may offer a shared-cost AVC scheme, both you and your employer contributing. This can make AVCs a cost-effective way to increase your pension savings.

In an alternative scenario, a shared-cost AVC scheme involves your employer and you both making contributions. These are typically deducted from your salary before tax, therefore providing tax relief for you from your overall tax bill.

Your AVCs are invested to grow your pension. The performance of these investments will determine the benefits you receive from your AVCs. It’s important to understand the risks associated with investing in AVCs. Although they offer the potential for higher returns, your investments could also decrease in value depending on the position of the stocks.

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AVCs in the Private Sector 

In the private sector, AVCs are commonly used instead of, or in addition to, workplace pensions. They provide a way for employees to increase their pension savings, whilst also potentially receiving a tax-free amount upon retirement. Employers in the private sector often provide AVC schemes as part of their pension offerings, allowing employees to make additional contributions to their pension pot.

Making AVCs in the private sector has its advantages, as it allows you to boost your pension savings. This can provide you with a larger pension pot and a potentially higher income in retirement. However, it’s important to understand the terms and conditions of your AVC scheme, which can vary between employers and sectors.

In the private sector, your AVCs are typically invested with the aim of growing your pension pot. The performance of these investments determine the benefits you receive from your AVCs, meaning it can go up as well as down.

It’s also worth noting that AVCs in the private sector are subject to the same tax rules as AVCs in the public sector. Therefore, within certain limits, you can receive tax relief on your AVC contributions.

AVCs and Divorce Settlements 

AVCs can be included in the divorce settlement if the event of a divorce occurs, with your pension benefits divided between you and your former spouse through a pension sharing order. The exact division of your AVCs will depend on several factors, including the length of your marriage and the size of your AVC contributions. The order can apply to all types of pension benefits, including AVCs.

It’s important to seek legal advice if you’re going through a divorce and have AVCs. A legal advisor can help you to understand how your AVCs might be affected, supporting you through the process. They can also protect your financial interests and ensure that you receive a fair settlement according to your needs.

A professional advisor may also help with any financial implications of a divorce. If your AVCs are divided as part of your divorce settlement, it could reduce your pension benefits and impact your financial security in retirement. Therefore, it’s crucial to consider all of your options, making informed decisions to secure your future.

AVCs and Divorce Settlements 

AVCs can be included in the divorce settlement if the event of a divorce occurs, with your pension benefits divided between you and your former spouse through a pension sharing order. The exact division of your AVCs will depend on several factors, including the length of your marriage and the size of your AVC contributions. The order can apply to all types of pension benefits, including AVCs.

It’s important to seek legal advice if you’re going through a divorce and have AVCs. A legal advisor can help you to understand how your AVCs might be affected, supporting you through the process. They can also protect your financial interests and ensure that you receive a fair settlement according to your needs.

A professional advisor may also help with any financial implications of a divorce. If your AVCs are divided as part of your divorce settlement, it could reduce your pension benefits and impact your financial security in retirement. Therefore, it’s crucial to consider all of your options, making informed decisions to secure your future.

FAQ

1. How does a tax-free lump sum relate to additional voluntary contributions (AVCs)?

When you retire, you typically can take out a portion of your pension pot as a tax-free singular amount, including money you’ve saved through AVCs. The AVCs you’ve made over time can significantly increase the overall amount which you withdraw upon retirement. However, it’s important to note that there are limits to how much you can take as a tax-free lump sum. Remember, any amount beyond this limit will be taxed.

In addition to providing a larger tax-free lump sum, AVCs can increase your retirement income. The extra contributions you make are invested, growing your pension and providing you with a higher income in retirement.

2. What is the process of deducting contributions for AVCs?

Deducting contributions for AVCs typically involves your employer taking the agreed AVC amount from your salary and depositing it to your AVC fund, before tax. This process is very beneficial for many people because it provides immediate tax relief. Essentially, you’re contributing pre-tax money into your pension. This makes AVCs a very tax-efficient way to save for retirement.

However, it’s important to remember that there are limits to how much you can contribute to AVCs and still receive tax relief. According to the HMRC, your contributions are limited to 100% of your earnings, or £40,000 per year, whichever is lower. Contributions that exceed these limits will be taxed

3. How can I use Pension Wise to understand my AVC options?

Pension Wise is a free, impartial government service that helps guide your pension options, including AVCs. They can explain how AVCs work, the potential pros and cons, and how they fit into your personal retirement planning and preferences. By using Pension Wise, you will be provided with insight into your AVC options to make an informed decision.

In addition to providing general guidance, Pension Wise can also help you to understand the tax implications of AVCs, including how the tax relief works and the rules around taking out a tax-free amount. Although Pension Wise can provide valuable information and guidance, seeking independent financial advice when considering AVCs is also a good idea to provide additional personalised support.

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4. Can AVCs supplement my state pension and main LGPS pension?

Yes, AVCs can supplement your state pension and your main Local Government Pension Scheme (LGPS) pension. The state pension provides a basic retirement income, but for many people, more is needed to maintain their lifestyle and remain financially secure. AVCs can provide a way to top up your pension, potentially producing a higher retirement income.

Similarly, whilst your main LGPS pension can provide a solid foundation for your retirement income, you might also want to save money alongside this to secure a comfortable later life. That’s where AVCs come in, making additional contributions on top of your LGPS pension.

5. What is a free-standing additional voluntary contribution, and how does it differ from other AVC options?

Free standing additional voluntary contributions (FSAVC) is a type of AVC separate from your workplace pension scheme. Unlike regular AVCs which are made to your employer’s pension scheme, FSAVCs are made to a pension scheme supplied by an insurance company or a building society. 

With FSAVCs, you have more control and flexibility over your investments, typically choosing from a wider range of investment options. However, FSAVCs might come with higher charges than regular AVCs, and they don’t benefit from employer contributions. 

Similar to other AVCs, FSAVCs provide a way to top up your pension and potentially increase your retirement income. However, it’s necessary to weigh the potential benefits against the risks and costs. Therefore, seeking professional financial advice when considering your AVC options is always advisable.

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Review of Article

This article has been reviewed by Saq Hussain, who is a pension and financial expert, with over 25 years experience of the financial services industry. Saq has regualrly featured in the UK press commentating on financial and specifically pension and retirement related issues.