What are AVCs?

Confusion surrounds Additional Voluntary Contributions (AVCs), what they are, who can use them and what they can be used for. Basically, they are a method of supplementing payments to a pension fund to ensure the maximum benefit during retirement. As the name suggests, AVCs are voluntary and are paid by the employee; they do not affect employer contributions to a pension fund. The only proviso is that the employee must be a member of an occupational pension scheme.

AVCs can be paid either into the main occupational scheme of which the person is a member or into a separate fund. One advantage of keeping them separate is that in the unlikely event of a pension fund being unable to meet its commitments, the AVCs would at least provide an alternative if invested elsewhere under a different investment manager. If part of the main pension fund, they too could be prone to any collapse.

What is sometimes confusing for people trying to understand AVCs is that there is no such thing as an AVC fund to correspond with the familiar pension funds one reads about. Essentially AVCs are long-term investments which can avail of full tax relief on pension contributions and are payable on retirement.

Restrictions on AVCs are few. They form part of the 15 per cent of gross salary which is eligible for tax relief if used as pension contributions. One need only ensure that at least one-sixth of eventual benefits are paid for by the employer - a situation unlikely to be breached - and that the benefits do not exceed the Revenue Commissioners' limits. These limits are generous. They allow for a pension of two-thirds of final salary in addition to the State pension and a tax-free lump sum of one-and-a-half times final salary. In addition, the Revenue allows for pension provision for dependants and to take account of inflation in retirement.

Why consider AVCs?

Everyone's pension requirements differ. What might appear to one pension scheme member to be generous financial provision for retirement might not appear sufficient to another, if they have a spouse, children, other dependants, a mortgage or sundry financial commitments to provide for. In deciding whether it is necessary to pay AVCs and what particular benefits should be sought, it is worth asking:

how is my pension likely to relate to my final pay?

what pension will be left over if and when I take a lump sum on retirement?

who are my dependants and how will they be provided for on my death - either in service or after retirement - and can I improve that provision?

what cost of living increases can I expect to receive on my pension after retirement and should I aim to make extra provision?

what is my pension position if I have to retire early due to ill health and can that position be improved?

Only on the basis of answers to these questions can AVCs be efficiently targeted at particular benefits.

Getting advice

As with most financial investments, it is worth getting good advice when choosing how to invest AVCs. Talk to a pensions consultant, not forgetting to ascertain whether they are tied agents or independent and what fees and charges they make.

It is worth noting that, recently, the lion's share of AVCs have been invested in defined contribution plans (85 per cent) rather than defined benefit plans. The former have the advantage that they are more flexible for the plan purchaser who can move funds around at various stages to maximise risk or security depending on priorities. The latter remove the element of risk and let you know exactly what benefits you are buying?

One thing to remember about AVCs is that, like ordinary pension fund contributions, they will be locked into the scheme until they are paid out in benefits.