You may already have been building up your retirement nest egg through your workplace pension scheme, but if you feel like cushioning it with a little extra padding for more comfort, then it might be worth looking into additional voluntary contributions (AVCs).
Or, if you’re nearing retirement and want to supercharge your pension to get the max out of it, you may want to consider topping it up with extra contributions while you still can.
Adrian Godwin, a financial and taxation planner, and founder of Oaktree Financial Services, says he would typically suggest a client considers AVCs if they wish to boost their retirement savings beyond what their employer’s pension scheme offers, or if they are nearing retirement and want to increase their fund quickly. It can also be a tax-efficient use of funds.
“Contributions are typically made from pretax income. If a client is looking to reduce their taxable income or maximise tax-relief benefits, AVCs may be suitable,” says Godwin. By contributing from pretax income, you’re not only saving for your future but also cutting down today’s tax bill – a win-win scenario.
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“For clients who are comfortable with investment risks and wish to influence how their retirement savings are managed, AVCs often provide a range of investment options,” Godwin adds. The flexibility of AVCs means you can diversify your portfolio and put some money towards higher-risk funds if you have the risk appetite.
A great advantage, then, is greater control over retirement planning, enabling individuals to tailor their savings strategy according to their own specific financial goals and timelines. “Further, as individuals can typically choose how much they wish to contribute, allowing for flexibility based on their financial situation,” says Godwin. “Contributions can often be adjusted over time.”
There can also be some disadvantages to putting money into an AVC, Godwin says. “Money contributed to AVCs is typically locked in until the individual reaches retirement age. This means that funds are not easily accessible for emergencies or other financial needs prior to retirement. Also, while AVCs provide tax relief up to certain limits, going over the annual allowance may lead to tax penalties. This can complicate financial planning, especially for high earners.”
There are a number of factors to consider when deciding if AVCs are right for you, including contribution limits, investment options, fees and charges, tax implications, risk tolerance and general pension scheme rules. “If you are considering looking at an AVC then make sure you get financial advice from a financial adviser to ensure you understand these implications,” says Godwin.
Another factor to consider is how you will access this money upon retirement.
“AVCs are often integrated with your main pension scheme. At retirement, the money may be considered part of your overall pension fund, and the options for accessing it will depend on the terms of your main pension scheme.
“Be aware of the tax implications when accessing your AVC. While a portion [up to 25 per cent] may be tax-free, the remaining funds withdrawn as income will be subject to income tax based on your total taxable income in that tax year.”
Depending on the rules of your pension scheme, there may be different routes for you to access your AVC funds upon retirement: you may choose to take a portion as a tax-free lump sum; you can use your AVC fund to purchase an annuity, which provides guaranteed income for life or for a specified period; or you might have the option to enter into a drawdown arrangement, where you keep the AVC invested while drawing income from it as needed.
“If you pass away before accessing your AVC funds, the value of those contributions may be paid out to your nominated beneficiaries, according to the rules of your pension scheme. This potentially provides financial support to your loved ones,” notes Godwin. Again, it all depends on the rules of your specific scheme, so if you’re thinking of going down the AVC route, speak to an expert and check out all the details to ensure that you’re making the smartest and most efficient use of your contributions.