Making Additional Voluntary Contributions (AVCs)

Making Additional Voluntary Contributions (AVCs) to your company pension

AVCs offer a cost-effective way to increase your pension fund if you have a company pension scheme. Following changes effective from April 2006, there are now more ways to pay extra funds into your pension.

Topping up your pension with AVCs

Company (‘occupational’) pension scheme contributions are normally made up of:

• your own regular contributions
• an amount from your employer

However, you might want to increase the value of your pension fund to provide additional benefits for yourself or your family, or because you started saving for a pension later in life.

One option is to make ‘top up’ payments from your salary, so you’ll receive a larger pension when you retire. These payments are known as AVCs and were offered by all company pension schemes up until April 2006.

Advantages of AVCs

You benefit from:

• lower administration charges in most cases than if you invested into a separate pension scheme
• the opportunity to stop or vary the amount you pay
• tax relief on your contributions (up to certain limits – read ‘Pension rules from April 2006′)

Some companies may no longer offer AVCs following changes to pension rules in April 2006, as there are now more options for topping up your company pension through other means.

• Pension rules from April 2006

How AVCs are used by your pension fund

The benefits you’ll receive from your AVCs will depend on the type of company scheme you’re in, and the rules of the scheme.

Money purchase scheme

With a money purchase scheme, your contributions (and those of your employer) are invested by an insurance company or a professional manager. The amount of pension you get depends on how much you’ve contributed and how well the investment has performed.

When you retire, the whole fund – including your AVCs – is used to buy your pension.

Final salary (defined-benefit) scheme

With a final salary scheme, the amount you get is based on your salary and the number of years you’ve been in the scheme. Sometimes AVCs increase the number of years your benefits are based on; sometimes they build up a separate fund to buy extra benefits.

You’ll need to talk to your pension scheme administrator to find out about your schemes rules.

• More about AVCs on The Pensions Advisory Service website (opens new window)
• Learn more about AVCs on the Financial Services Authority website (opens new window)

AVC refunds

If you die, your AVCs are usually repaid – together with any interest earned. However, this depends on the rules of your scheme, so you’ll need to check with your pension scheme administrator.

• What happens to your company pension when you die (opens in new window)
  

Free-standing AVCs

Free-standing AVCs (FSAVCs) differ from ordinary AVCs because they’re:

• arranged by you, not through an employer
• paid into a pension scheme run by a financial institution such as an insurance company or bank

The advantages of FSAVCs are:

• you can continue to pay into a scheme even if you change employer
• they may give you more investment options

However, the administration costs will usually be higher.

• Read about FSAVCs at The Pensions Advisory Service (TPAS) website (opens new window)

Pension rules from April 2006

Up until April 2006, restrictions on how much you could put into a company and personal pension at the same time meant that AVCs sometimes offered the only option for topping up your pension.

However, following the April 2006 changes, you can now save as much as you like into any number of pensions schemes (company and personal – including stakeholder), including through AVCs and FSAVCs. You will get tax relief on your contributions of up to 100 per cent of your earnings each year, subject to an upper ‘annual allowance’. (Savings above the annual allowance and a separate ‘lifetime allowance’ of total pensions savings will be subject to tax charges.)

Pension rules from April 2006

Pension rules

Since April 2006, simpler rules have been applied to both personal and company (occupational) schemes. The new rules allow most people to pay more into their pension schemes – and on more flexible terms.

Saving more into your pension

You can now save as much as you want into any pension scheme. The rules for claiming tax relief on your pension contributions are also more flexible, though tax charges will apply if you go above certain new allowances.

Abolition of pension contribution limits

• you can now contribute as much as you like into any number of pension schemes (personal and/or company) each year, and there is no upper limit to the total amount of pension saving you can build up

Tax relief on pension contributions

• each year you will receive tax relief on your pension contributions up to 100 per cent of your earnings (salary and other earned income) subject to an  ‘annual allowance’ above which tax will be charged (more below)
• if you have little or no earnings and are in a ‘relief at source’ scheme, you will still get tax relief; for every £80 you contribute in a tax year, the government will contribute a further £20 until the total value of contributions reaches £3,600 for the year

Annual allowance above which contributions will be taxed

• yearly pension savings above a new ‘annual allowance’ taxable at 40 per cent, whether made by you and/or your employer
• the annual allowance for the tax year starting 6 April 2006 will be £215,000 and will rise each year until it reaches £255,000 in 2010; thereafter the amount will be reviewed every five years
• if the annual allowance is exceeded you’ll need to declare the extra pension savings and pay the annual allowance charge through Self-Assessment
• the annual allowance charge will not apply in the year you take all your benefits

‘Lifetime allowance’ above which a tax charge will apply

• you will now have a ‘lifetime allowance’ against which the total value of the benefits built up in your pension fund/s by you and/or your employer (including investment growth) will be tested
• the value of any pensions savings above the lifetime allowance will be subject to a ‘lifetime allowance charge’; this will apply in addition to the usual Income Tax due on pension payments
• the lifetime allowance for the tax year starting 6 April 2006 will be £1.5 million and will rise each year until it reaches £1.8 million in 2010; thereafter it will be reviewed every five years
• if you take benefits above your lifetime allowance as a pension, the lifetime allowance charge on the excess amount will be 25 per cent
• if you take benefits above your lifetime allowance as a lump sum, the lifetime allowance charge on the excess amount will be 55 per cent
• the lifetime allowance ‘test’ will take place when you start drawing your benefits or when you reach age 75 (in this case tax would be payable as if you were drawing an income from the pension; you can’t take a lump sum once you reach age 75)

If your pension is close to, or above, the initial lifetime allowance figure it’s important to seek specialist advice about how you might protect your pension from the lifetime allowance charge. Protection can be obtained up to 5 April 2009. You can also get general advice from The Pensions Advisory Service on 0845 601 2923 (open 9.00 am to 5.00 pm Monday to Friday), or you can speak to a pensions adviser.

• Choosing and using a pensions adviser
• The Pensions Advisory Service website (opens new window)

More flexible pension scheme investments

Since April 2006 certain pension schemes are allowed a wider choice of investments, subject to certain rules. To find out more, speak to a pensions adviser.

More choices for how and when you take your pension

There is now more choice for how and when benefits can be taken - as described below. However, bear in mind that pension schemes are subject to individual rules, so you’ll need to check with your pension administrator what your particular scheme allows.

More ways of taking your pension income

There are now four choices:

• take a scheme pension – a secured pension for life paid out of the scheme assets
• buy an annuity (an investment that provides a regular income for life)
• draw an income directly from your pension fund, as an ‘unsecured pension’ before age 75
• draw an income directly from your pension fund, as an ‘alternatively secured pension’ from age 75

A more generous tax-free lump sum

All types of pension schemes are now allowed to pay a tax-free lump sum of up to 25 per cent of the value of your benefits, provided there is provision in the scheme rules, to an overall maximum of 25 per cent of the Lifetime Allowance. Tax-free lump sums are not available once you reach age 75.

For more information on ways to take your pension, visit the Financial Services Authority (FSA) website.

Working and drawing your company pension

If you’re a member of a company pension scheme, you no longer have to leave your job to draw a pension.

You may also be able to draw all or some of your pension while still working full- or part-time for the same employer, depending on your pension scheme’s rules.

Changes to pension ages

By April 2010, the minimum age at which you’ll be able to take your company or personal pension will have increased from 50 to 55.

However, you may still be able to take your pension before age 55 in certain circumstances, for example if you are unable to work due to ill-health. Your pension administrator will be able to tell you what your scheme allows.

Between 2010 and 2020 the minimum age at which women will be able to their State Pension will gradually rise from 60 to 65.

More useful links

• HMRC guidance on new pensions rules (opens new window)
• FSA factsheet: retiring soon – what you need to do about your pensions (PDF document 226k) (opens new window)
• The Pensions Advisory Service summary of pensions rules (opens new window)
• Financial Services Authority overview of pensions rules (opens new window)
• Help with PDF files

Understanding company pensions

If your employer offers a company (‘occupational’) pension scheme, it means the company usually contributes towards your pension. There may also be payments to a spouse, civil partner or dependant when you die.

Types of company pension

Company pension schemes vary from company to company. Your scheme is likely to fall into one of two general types – a ’salary related’ or ‘money purchase’ scheme.

Salary related scheme

In a salary-related scheme the amount you get is based on your salary and the number of years you’ve been in the scheme.

Money purchase scheme

With a money purchase scheme the amount you get is based on how much has been paid into the scheme and how well the money has been invested.

On retirement, your fund is used to provide your pension, usually by buying an annuity (a regular income for life). The amount that you get will depend upon various things such as your age, gender and health and, with some types of scheme, your marital or civil partnership status.

Contributing to a company pension

Company pension schemes usually require you to make a regular contribution based on a percentage of your salary. You may also be able to boost your benefits by making additional voluntary contributions (AVCs).

You get ‘tax relief’ on the money you pay into your pension. This means you pay less tax because your employer takes the pension contributions from your pay before deducting tax (but not National Insurance contributions).

If you joined your company pension scheme during or after 1989 you were restricted on how much you could put into your company pension scheme.

However, following changes to pension rules in April 2006, you can now save as much as you like into any number and type of pensions (irrespective of age) – and get tax relief on contributions of up to 100 per cent of your earnings (salary and other income) each year, subject to an upper ‘annual allowance’.

Savings above the annual allowance and a separate ‘lifetime allowance’ will be subject to tax charges. These allowances will be restricted if you become unemployed and wish to continue to pay into your pension scheme.

The lowdown on final salary pension schemes

About 8.5 million people have a final salary pension scheme. But if you pay into one each month, where is your money going, and more importantly is your future wealth safeguarded?

Final salary schemes, also known as defined benefit schemes, can be very generous.
They pay staff a set percentage of their final salary depending on their length of service.
But there is a general concern about pensions in general, following the Equitable Life debacle and pensions mis-selling in the 1980s and early 1990s.

More recently, reports have highlighted concerns over the funding of final salary schemes, with a number of FTSE 100 companies now thought to be facing a cash shortfall.
So if you do have a final salary scheme, what questions should you be asking your employer and what information can you glean from your pension provider?
How solvent is the fund?
Each year a report is produced by the trustees of your pension scheme and every three years there is a valuation by actuaries, who analyse financial risk.
Since 1986, scheme members have been entitled to obtain this information from their pension fund’s trustees.
You must write to the trustees of your pension scheme and receive it within two months of applying.

“Information from the actuary can be complicated and the full valuation is anything up to fifty pages long and is not an easy read,” says Joe Robertson, regulatory director at the Occupational Pensions Regulatory Authority (Opra).
But if you can not understand the figures and jargon, and your company’s pension manager is unwilling to help, there is an organisation that can.
The Pensions Advisory Service (OPAS) is for people who need help with their occupational scheme and can be contacted on 020 7233 8080 or via its website (see links on right).
How much is my pension worth?
If you are paying into a final salary pension scheme, the amount of money you receive when you retire will depend on your final salary and how long you have worked for the firm.
The trustees are not obliged to send you an annual statement automatically (though some do). If you do want it, you can request this in writing.
Ask for an “annual benefits statement”, which will give you an indication of the level of benefits you are entitled to under the scheme.
It must be sent to you within two months.
You could also ask for your fund’s “transfer value” which will give you an idea about how much your fund would be worth if you wanted to transfer it elsewhere.
Write to the trustees or your pension fund manager. This information must be provided within three months.
Can I have my pension cut?
The trustees of your pension fund can not retrospectively cut your accrued benefits without your consent.
But they can normally adjust the level of future benefits.
This is a common way of making up any deficits within the pension fund.
However, this may contravene employment law if it contradicts the terms of your original contract.
How solvent is my employer?
“You should look at how financially stable your employer is,” says Tom McPhail, a pension expert from independent financial adviser Torquil Clark.
If your employer goes bust, it can not touch your pension fund but you may not get as much as you had originally thought.
If there is not enough money to fund everyone’s scheme, then you may be required to buy a deferred annuity.
The insurance company will then estimate your pension on an assumption of what your final salary pension scheme is at the moment.
As the insurance company will now be guaranteeing your pension fund, you may get less than you had expected.
The Pensions Advisory Service says: “If the company winds-up, it is not the responsibility of the employer to meet the full pension liability – only the transfer value.”
Have I spread the risk of my investments?
Tom McPhail, a pensions expert at Torquil Clark, says it is imperative for people to spread the risk of any investments.
“We have had so many people saying that they have had everything with Equitable Life in recent months.”
If you are investing in a pension, make sure that you spread the risk across different fund management companies, so that if one company goes bust – you will not lose all your money.
Further information:
Contact the Pensions Advisory Service (OPAS) for general pensions information or if you are in dispute with your company’s pension scheme.
Contact OPAS help line on 0845 6012923.
If you have a dispute that you can not resolve with your employer or Opas you have the legal right to refer your complaint to The Pension Ombudsman deals with serious complaints. Write to Pension Ombudsman, 11 Belgrave Road, London SW1V 1RB.
The Occupational Pensions Regulatory Authority (Opra) deals with complaints about occupational schemes. Contact 01273 627600.

Final Salary Pension Schemes Under Attack

Pension provision has never been so controversial. In the late 1980s and early 1990s there were scandals about funding, surpluses and mis-appropriation of pension scheme assets. In the mid 1990s there was the mis-selling scandal. Now final salary pension schemes are under attack and millions of occupational scheme members are worried about their future. This leaflet explains the background to the crisis and what rights members have.

What has gone wrong?

Contrary to popular belief the new accounting standard, FRS 17, imposed by the Accountancy Standards Board is not to blame. FRS 17 has no direct bearing on the funding of pension schemes. All it does is deal with the way in which pension scheme assets appear in the employer’s accounts. So the extent of the deficit is revealed by, not caused by, FRS17.

The blame has also been put on the Minimum Funding Requirement imposed by the Pensions Act 1995. Although the MFR is very artificial because it values investment returns in a prescriptive manner which doesn’t reflect the pension scheme’s security of funding, the problem, from an employer’s point of view, is that the legislation imposes a statutory obligation to make the deficit good within a specified timetable.

The economic background to pension scheme funding is the real reason for the crisis investment returns are falling and annuities are increasingly expensive. At the same time, assumptions made by actuaries about life expectancy have been changing to reflect trends in longevity.

The removal of Advance Corporation Tax Credits took a reputed £5bn annually off the collective value of occupational pension schemes in the country.

Instead of providing a cushion for the future, schemes have been underfunded to the extent that surpluses in the late 80’s and early 90’s were used to take contribution holidays.

It is only now, when employers have to contribute again, that they have realised the open-ended nature of the commitment to pay the balance of costs in a typical final salary pension scheme.

Their solution has been to close the scheme and offer a defined contribution scheme as an alternative. This transfers the problems associated with investment returns to the membership.

A contractual right?

The deeds and rules governing the typical final salary pension scheme will not usually help a member to insist on remaining an active member of the scheme in question. Unless something went seriously wrong when the scheme was drafted, the employer will have reserved the right to cease contributing.

At that point the trustees may have a right to keep the scheme going as a closed scheme, but if there is no more money coming in then sooner or later the scheme will go into wind-up. The employer’s decision to stop contributions is constrained by the duty of good faith but that is all.

An employee defending their right to continue active membership will have to turn to the terms of the contract which they have with the employer. The typical contract of employment or letter of engagement will say something to the effect of:

“There is a company pension scheme which you are/may be entitled to join. Details are set out in the member’s guide to the pension scheme and further details can be obtained from the pension scheme administrator.”

The reason why there is this provision is because Section 1 of the Employment Rights Act 1996 requires every employer to provide a statement of the main terms and conditions of employment including pensions.

The Occupational Pension Schemes (Disclosure of Information) Regulations 1996 requires the provision of an outline of the principal terms of any occupational pension scheme to members (actual and potential) – usually done by providing a handbook of some description.

It is important to note however that the statutory statement of terms and conditions is just that: a statement which outlines the terms of employment. It may reflect the actual provisions of the contract of employment. But not necessarily.

Those terms may actually be contained:
in a job description
in a collective agreement incorporated into the contract
in a company manual
in an advertisement for the job.

If the contract contains contradictory provisions the affected employees can go to an Employment Tribunal to get the Section 1 Statement corrected.

The typical contract of employment refers to a handbook containing words such as:

“The company regards the pension arrangements which it offers as an important part of the remuneration package and has no current intention of changing the scheme. Nevertheless the scheme may be amended in accordance with its rules and the company reserves the right to terminate it without necessarily providing a replacement.”

An employer which doesn’t make that sort of reservation is in trouble. But if there is such a power, it can be used, and using it does not amount to a breach of contract. It must be exercised in good faith, but as the House of Lords said in the leading case on the subject:

“…it must be open to the company to look after its interests, financial or otherwise, in the future operation of the scheme…”

Acting in its own selfish interests doesn’t mean that the company is not acting in good faith, provided it has no ulterior motive, and has properly considered what it is doing and considered (but not necessarily given any great weight to) the interests of scheme members.

Terms incorporated from a collective agreement (or implied by custom and practice) may give rise to a right to join a pension scheme and the right to join to remain a member.
As a matter of law, however an express term of the contract will overule an implied term. Reserving the power to amend or terminate contained in the handbook is an express term.

Employers sometimes make commitments unintentionally. The High Court has held that promises made to encourage members to transfer pension benefits to a new scheme can amount to negligent misrepresentations, entitling members to damages.

The same principle can attach to promises of future benefits under an existing scheme when it is reorganised. Existing members are usually told that they will retain the same benefits in the future. That can easily end up being a commitment to provide the same or no less favourable benefits into the indefinite future.

Various types of scheme ‘closure’

Closure to new entrants

This is the most typical case. Existing members carry on as before, but new employees will be offered membership of an inferior money purchase scheme.

It isn’t possible to breach a contract which doesn’t yet exist, and new employees are offered a job on a take it or leave it basis.

The rules of the scheme and the company handbook may say that all employees are automatically members of the company pension scheme unless they opt out of membership, but this is very rare. The rules can always be changed anyway.

It is more common that the scheme provides for membership at the company’s invitation, or that members have to opt in rather than opt out. It is much easier for the employer to assert that it has achieved its aim, even though mistakes were made in the contractual documents, simply by saying “you can’t join anyway because I won’t invite you to”.

Excluding the right to future accruals

Closing the scheme to new members will not solve an immediate funding problem for the employer. The savings take time to come through. A more radical step is to close the scheme to current members, in the sense that they will not be allowed to accrue any future benefits.

This will usually require an amendment to the rules of the scheme. But while Section 67 of the Pensions Act 1995 will prevent amendments which adversely affect accrued rights or entitlements, it means past service benefits and not future accruals.
However the amendment power in the scheme documentation sometimes states that it protects future accruals too.

Winding up

This is the heavy-handed approach, and will cause the employer more problems than it solves. During the course of the wind-up the employer will have to pay off the deficit on the demand of the trustees. And since they must act in the best interests of scheme members they will use this power to extract the maximum payment. They can probably exercise the power more than once in the course of the wind-up.

The issue for the scheme’s members however is that the deficit on winding up is much more substantial than the deficit on an ongoing basis, and benefits are not likely to be secured in full.

The point is whether the employer is obliged to meet the whole deficit as a contractual right, or under the scheme documentation.

Some cases proceed on the basis that the employer’s obligation is to contribute whilst the scheme is ongoing, but the obligation ceases once the wind-up starts.
The employer can simply walk away from the mess under this approach, leaving the trustees to pay accrued benefits as best they can.

Other cases proceed on the basis that the employer’s obligation is to pay benefits. So pensions are deferred pay and the scheme is nothing more than a means of providing the funds.

If there is a solution to the worries of the members, it probably lies in the hands of the trustees. Even if the employer’s obligation to fund benefits ceases once it has given notice that it will do so the obligation to pay the balance of costs continues until the employer’s notice expires. If the trustees can do so under the scheme documentation, they can and should demand a one-off deficit payment to meet the full balance of costs before the notice expires.

Protecting employees

In almost every case, an employer which wants to terminate its final salary scheme is going to be able to do so. While sloppy drafting of the scheme may cause the employer problems, the best protection for scheme members is more likely to come from negotiations rather than threats of legal action.

The most important aim in negotiations is going to be to keep some form of final salary scheme going, even if the accrual rate is worse, or the retirement age goes up, or favourable ill health benefits have to be sacrificed.