Given the unparalleled tax advantages of additional voluntary contributions (AVCs), it is surprising how little publicity they receive compared to other less tax efficient long-term savings vehicles. AVCs have never been regarded as sexy, and the market has been tarnished by the demise of Equitable Life, a major AVC provider. However, there are compelling reasons to use AVCs to boost retirement income.
The potential market is huge. According to the last annual survey of occupational schemes by the Government Actuary’s Department (2006), approx. 400,000 members in private occupational schemes paid AVCs, about 1 in 10 active members. Information about who is making additional contributions in contract-based schemes is difficult to gauge.
Virtually every member of work-based schemes has scope to improve their main scheme benefits. The tax regime for AVCs underwent a major shake-up in 2006, but the new tax rules now provide even greater incentives to save.
Perversely, despite the decline in long-term savings, the Government decided that after April 2006, employers are no longer required to offer an AVC facility within their company scheme. But, there is little evidence of employers removing this option.
Employees can now pay up to 100% of earnings in AVCs and receive full tax-relief on these payments. At retirement, 25% of their AVC account value can be taken as Tax free cash (TFC). Previously, only those making AVCs before 1987 were permitted to take TFC.
AVCs should have very wide appeal. Payroll deduction is a simple mechanism for providers to collect payments, and savers quickly adjust to their new level of net pay. Millions of members entitled to top rate tax relief (currently 40%) on contributions are likely to have their retirement income only taxed at the basic rate (currently 20%).
AVC savings cannot be withdrawn until retirement. But this should be promoted as a positive feature of earmarking money for use in retirement. Of course, contributions can be stopped or suspended if no longer affordable. The generous contribution allowances enable ISA savings accounts to be utilised as single premium investments into AVC accounts.
People with significant savings, who object to buying an annuity with their AVC account, can now purchase a drawdown product with their retirement pot.
Credit crunch – a timely reminder
Over the past decade, millions of home owners have benefited from rising property values. With consistently strong growth, many people have shunned AVCs, regarding their family home as a potential source of extra income in retirement.
But the ‘credit crunch’ has demonstrated that property markets can dip, with most pundits predicting further falls. This past year proves that even UK residential property prices are not immune from market adjustments.
Now is the right time to challenge the popular view that using equity in the family home to boost income in retirement is preferable to saving via a pension. Of course the argument has attractions. Property is a real investment, with the asset being enjoyed as a benefit throughout the working life.
But ‘trading down’ at retirement, to release capital, in reality could prove very difficult, particularly in a depressed market. The emotional ties of selling the family home and/or leaving neighbourhood friends are often overlooked until the event, as are the significant costs of selling and buying another property.
With ever improving life expectancy, using an Equity Release Scheme may only be viable late in life and long after retirement. Generally there is a poor understanding amongst consumers about just how much capital is required to secure a significant additional income.
There is a great deal more the Government and pensions industry could do to raise the profile of AVCs and place it firmly on the retirement savings radar.