Over-50s finance: It's time to learn your... AVCs
Additional voluntary contributions are extra savings you can make to your pension, and a great way to boost your tax-free lump sum, writes John Cradden
It might be another bewildering acronym that the pension industry is fond of coming up with to name products, but AVCs (additional voluntary contributions) make a lot of sense to the retirement saving plans of many over-50s.
AVCs are extra savings you can make towards your pension. Doing AVCs can enhance your final tax-free lump sum, provide you with additional retirement income and allow you to take full advantage of the pension tax relief available to you, particularly when you're older.
"AVCS are a too well-kept secret in the pensions world," said John McInerney, a pensions expert at Standard Life. "Everyone saving for a pension should know about them and avail of them if they can manage it."
Standard Life's most recent survey from last year shows just 4pc of people invest in AVCs. "We have checked this regularly over the last eight years and the survey results over the years is consistently between 4-5pc," said Mr McInerney.
"If you're older and nearing retirement, maybe the question is how much you can invest in them to make your nest egg as big as possible?" he added.
Frank Conway of Irish Financial Review said AVCs are an important means of increasing the value of a pension fund using the tax efficiency permitted, particularly in the last 15 to 20 years of your working life.
For instance, once you reach the age of 50, you can contribute up to 30pc of your income tax-free to your retirement fund, a ratio that rises to 35pc when you hit 55, and 40pc from the date of your 60th birthday.
AVCs are 'rocket fuel' for making your pension fund grow fast, according to Mr McInerney.
Using the example of a client, €36,000-worth of savings to an AVC fund (€500 per month) was invested over a 72-month period between 2009 and 2015 in a mixture of Standard Life GARS funds, a UK fund that invests in small firms, corporate bonds and an Indian equity fund. This fund has grown to €55,000 - a growth of €19,000.
Jerry Moriarty of the Irish Association of Pension Funds says your AVCs allow you to maximise the tax-free cash you can take, and this may well work out better for you financially but much depends on your individual circumstances.
"For example, in a private-sector defined benefit scheme you can take tax-free cash by giving up some pension benefit. Depending on the conversion rate of income to cash, it may be more beneficial to maximise the income from the scheme and use the AVCs as tax-free cash."
Mr McInerney certainly advocates using an AVC to boost the tax-free lump sum so that you can preserve the retirement fund that will provide the annual income.
For instance, if you were in a fully funded scheme with a final salary of €60,000, you can look forward to a final salary in retirement of €30,000. Revenue rules allow you to take up to 1.5 times the €60,000 as a tax-free lump sum. However, you would have to sacrifice some of your annual pension income at a rate of €1 for €9 to get that lump sum from the scheme, says Mr McInerney, which would reduce your pension income by €10,000 a year in order to secure a tax-free lump sum of €90,000.
"The tax-smart way to boost your retirement fortunes is to ensure you save for this tax-free amount via AVCs and use the AVC fund to get your lump sum rather than forfeit your pension income."
Mr Conway warns that how much you can take as a retirement lump sum under an AVC will depend on the company's pension plan, your personal circumstances and how long you've been working for the company.
"For example, if you are allowed 150pc of your final earnings as a retirement lump sum and your company pension gives you 100pc, you can use your AVC to make up the other 50pc."
Mr Moriarty strongly recommends talking to your company's pension scheme trustees to see what AVC arrangements they have in place as they may have negotiated a competitive charging structure."Many defined contribution schemes now offer matched contributions where the employer will pay more if you also do. Obviously this should be the first thing you should do if you are considering paying more."
As a product type, AVCs seem simple on paper, but in reality they can be quite complicated, so it makes sense to seek out independent advice.
"There are lots of different possibilities and rules when it comes to paying AVCs and having benefits paid," said Mr Moriarty. "This can be further complicated as more people have bits of defined benefit pensions, defined contribution pensions and AVCs. It really makes sense to engage an independent financial adviser to ensure you get the best outcome for you."
Even after you officially retire and start drawing down a pension, there is nothing to stop you continuing to save and invest.
Indeed, many retirees will continue to work part-time and many intend to stay active in the workforce after they retire, but with a better work/life balance.
Mr McInerney says: "Remember, you can still invest in a pension, benefit from the income tax relief on same and you can still invest in AVCs if you haven't exceeded the annual earnings limit of €115,000."
Early access to AVCs
Another little-known fact about AVCs is that, unlike most other pension funds, they can be accessed on a once-off basis in a financial emergency.
In its 2013 Finance Act, the Government introduced a provision for some people to access up to 30pc of their AVC funds, and only until March 2016. The move came after some lobbying by consumers who wanted more flexibility to access their pension funds in financial emergencies.
The argument they made was that many self-employed people couldn't afford to run their businesses, even though they had built up substantial pension savings which if they could access, would help them get through the downturn.
So the Government responded, but the sting in the tail was that anyone who did this would be taxed on the money they withdrew at their marginal rate of tax, and would also likely face a bill for the USC and PRSI.
It was estimated that some €200m would be withdrawn from AVC pensions over this three-year period, but the hefty tax charge on withdrawals appears to have limited the interest in this scheme.
In addition, the scheme is restrictive in that it only applies to AVCs paid into occupation pension schemes and PRSAs. It excludes employer-paid contributions, regular employee contributions and self-employed personal pension plans.