What is an AVC pension and how does it work?

An Additional Voluntary Contribution (AVC) pension is a way to make additional flexible contributions to your workplace pension.

You’ll enjoy government tax relief on anything you put in, up to your annual allowance, and may also get other perks such as lifetime income from your contributions.

It’s often known simply as ‘AVCs’, so employers may talk about ‘making AVCs’ to your workplace pension – but these additional contributions are typically held in a separate fund.

Here’s what you need to know about AVCs.

What is an Additional Voluntary Contribution (AVC) pension?

All employers must offer workplace pensions to qualifying employees, although many were already providing them before it became mandatory.

With your workplace pension, there is a minimum contribution requirement of 8%, with at least 5% from the employee and 3% from the employer, and the scheme may also have a maximum contribution limit.

However, it is often possible to pay more into your workplace pension (within your allowances) by using an AVC pension in addition. Your employer may offer this as part of their pension scheme.

There are two broad types of AVCs: defined contribution and defined benefit.

The first takes the form of a pot of money and will be affected by:

• How much you choose to save each month
• How much your employer contributes
• Charges or deductions made by your pension provider
• How your investments perform and how long your money has been invested

It’s often put in place by an employer, but can also be taken out with a pension provider independently (discover more about the best pension providers available here).

A defined benefit AVC, on the other hand, will always be connected to a workplace pension.

This will provide you a guaranteed income for life, calculated in a similar way to a standard defined benefit (DB) pension.

This calculation is usually decided on three factors:

• How many years you’ve worked for your employer, and how long you’ve been contributing to the defined benefit AVC for
• Your earnings – this can either be your final salary (how much you’re earning just before retirement) or career average (the average amount you earned across your career with that employer)
• Your accrual rate – the proportion of your earnings you’ll receive for each year you’ve paid into the scheme

Defined benefit schemes are more common if you work for the public sector, in the NHS, or as a teacher, as it can be expensive to maintain this type of scheme.

How does an AVC pension work?

You choose how much you contribute to your AVC pension every month. This amount can go up or down depending on how much you’d like to save.

Your employer may offer a matched contributions scheme for AVCs, which will boost how much you’re able to save, but they may not offer this if they already offer minimum workplace pension contributions.

If your scheme is a defined contribution (DC) one, then the AVCs you make will be invested in a fund of assets, just like an ordinary pension pot.

There is a risk of these investments fluctuating in value, but over time an AVC pension should hopefully deliver significant growth. If you’re part of an AVC pension scheme run by your employer, your contributions will be deducted from your monthly pay before you receive it.

If you choose to take one out privately, you will need to organise directly with your pension provider when, and how much, you will contribute every month.

You can pay as much as you like into your AVC pension up to the contribution limit that applies to all your pensions collectively (except the state pension, which you don’t technically pay into).

What are the advantages of an AVC pension?

One of the biggest perks of an AVC is you don’t have to commit to saving a set amount every single month.

While your employer may have a minimum contribution, you can also choose to save more whenever you can.

If you’ve got an expensive month coming up, you can cut your contributions back to the minimum without any penalties.

AVC pensions are eligible for government tax relief on pension contributions, which gives a significant boost to everything you save into them.

As a result, an AVC pension can be a particularly tax-efficient option for people with higher incomes as it allows you to save more of your money to enjoy in later life.

What are the disadvantages of an AVC pension?

If you opt for an AVC pension through your employer, you won’t have as much flexibility as other private pension options.

The money tied up in your AVC may be locked until you begin taking money from the main pension scheme.

While some AVCs can be maintained if you move companies, you may not be able to continue building it if you leave your role.

As you are putting your money into an investment pot with an AVC pension, there is always a chance that the value of your pension fund could go down in the short term as well as up.

That said, pensions are generally safer than most types of investments due to the tax advantages and being designed to use long-term.

Can I take my AVC pension as a lump sum at age 55?

You can access an AVC pension from the age of 55 (57 from April 2028), regardless of whether you’re still working or not.

You can, of course, leave it invested to continue growing. You’ll need to check the rules of your chosen AVC, as DB AVCs may not allow you to do this.

You can take up to 25% of any DC pension as a tax-free lump sum.

However, if you take more then it will be taxed as income for that year.

Who typically takes out an AVC pension?

Many public sector workers, such as teachers, NHS and local government employees, will have the option to join a public AVC.

These can be particularly lucrative, especially if your employer offers a defined benefit AVC, as it could secure you a healthy yearly income for your retirement.

Many in the private sector are also drawn to AVCs, thanks to matched contributions or simply as a way to add more money to their pension.

You may also take out a private AVC pension if you’ve maxed out your allowance in other retirement-focused savings or investments, such as individual savings accounts (ISAs).

If you have excess salary, you may be able to save up to the maximum annual pension allowance of £60,000.

Is an AVC pension a good idea for me?

If you’re looking to build a strong pension pot, an AVC pension can be a great option.

Even if your employer doesn’t offer a matched AVC pension, you can contribute as much or as little as you like every month.

Quite simply, all the usual advantages of a pension apply to an AVC pension.

What happens to my AVC pension if I die?

Many AVC pensions can be paid to your next of kin if you die.

Generally, a lump sum totalling its value to date will be paid to your spouse or partner, or a dependant if you are single.

If you have no next of kin, the money can go to your legal representative. Find out more about pensions and inheritance.

What is a Free Standing Additional Voluntary Contribution and how is it different?

You can also contribute Additional Voluntary Contributions without your employer setting the scheme up.

Free Standing Additional Voluntary Contributions (FSAVCs) are designed to supplement your company pension, but contributions won’t be taken from your salary and it won’t be linked to your workplace scheme.

You’ll choose a pension provider, set it up yourself and pay contributions directly, but enjoy the same tax benefits as a company AVC.

What are the alternatives to an AVC pension?

There are many alternative options to AVCs. You can opt for a group personal pension (GPP) instead of a group AVC, which will invest your money in stocks and shares as part of a collective fund.

If you don’t have the extra funds available for an AVC, your company pension alone is a valuable asset in its own right.

Other pension options include:

• Self-invested personal pension (SIPP)
• Personal pension
• Salary sacrifice
• Property investments (including buy-to-let)

How can I access my additional voluntary contribution pension?

When it’s time to access your pension (from the age of 55 or 57 from April 2028), you’ll need to contact your pension provider to discuss how you’d like to use the money.

Even if your pension has been set up by your employer, you should have been given details that let you view and manage your pension. The best approach for accessing your pension is to contact a financial adviser first.

Get expert financial advice

An AVC pension is a flexible option that offers tax benefits along with increased retirement savings. However, there are pros and cons to consider.

Let Unbiased match you with a financial adviser for expert financial advice to help you optimise your retirement strategy.