I’ve divided this blog into two- the first bit’s for the people who have charge of defined benefit schemes and relates to the DC savings plans that members can use to supplement their pensions (AVCs).
The second bit’s for the members, but it will probably be helpful for those in charge – who may be members – and may have the job of explaining these complicated things in simple terms.
I recently had to make decisions on the AVCs I paid, and much of this relates to my personal experiences. I was lucky, I had plenty of help.
I am not a tax expert and I don’t know my way around all the arcane rules that govern AVCs ( the older the more complicated) but there are people who do , who are there to help you and this article is here to help those people who might otherwise google – stick to the true and trusted sources – your scheme administrators, your trustees and the Government helplines that really are impartial/
This bit’s for trustees and DB sponsors
Back in the day when corporate benefits structures were about defined benefit pension schemes, additional voluntary contributions were considered very important.
To those who have paid them, they still are.
But the focus has shifted and nowadays the AVC schemes set up in the last quarter of last century are consigned to the legacy cupboard.
Trustees have got better things to worry about, like keeping tPR and the sponsor happy.
But the money in these AVC schemes with the likes of Prudential, Standard Life, Aegon, Aviva and the Equitable Life is still the trustee’s responsibility, they own the policies not the members and they have a fiduciary duty to ensure these schemes are giving value for money. Increasingly the DWP – through tPR – is looking at value for money as the primary concern of trustees looking after DC benefits.
In its recent investigation of transparency, the DWP’s Work and Pensions Committee called for a definition of value for money that could be applied across all DC pension pots. We have given a lot of thought to what that definition should be.
What “value for money” means to members
The two things that concern someone saving into a DC pot (AVC or otherwise) are money-in and money-out. Money goes into the pots by way of regular and special contributions, in the case of AVCs from payroll. Money comes out of AVCs into annuities, as cash (sometimes tax-free) or into personal pensions which are used for drawdown.
Value for Money is a measure of what happens between “in and out” and is best measured as the internal rate of return achieved uniquely by each contributor. Each contribution history is unique as is the output – the net asset value – or in the case of with-profits investments, the plan value.
But simply giving a member his or her internal rate of return (IRR) is meaningless unless it is compared to a benchmark. If benchmarked, the IRR can show whether the AVC has done better or worse than average, what the value for money has been.
Creating the benchmark and a VFM score
Until now, no organisation has created a meaningful benchmark, against which to measure the internal rate of return of AVCs for VFM purposes.
Which is where AgeWage comes in. We have co-created a benchmark with Morningstar , the rating agency. We have used indices going back to 1997 and fund-baskets before then, to create a daily price track representing the fluctuations of a typical DC pension fund going back to 1980. Investing a contribution history into this price track creates an alternative IRR, being what the average AVC saver would have got.
We are able to calibrate the difference between “achieved and average” to create a score out of 100 – with 100 being outstanding and 0 being dire.
Better still, the universe of data we have already built up makes this score comparable to the VFM members may have got from other pension contributions, for instance into workplace or stakeholder pensions, even DC pensions in payment.
What AgeWage scores mean to trustees
Trustees running DC schemes (which we take to include DC AVC plans), have a fiduciary duty to get value for their members contributions (money)
Their care on this matter is likely to be scrutinised by tPR.
Trustees are vulnerable to criticism and even censure – if they have no regard to member’s voluntary contributions.
But more important than “compliance” with regulation, we believe that the reputation of trustees as upholding member’s interests is of critical importance, especially where those trustees are under pressure to add value
This bit’s for members
I’m surprised by how little attention is paid to helping members of DB plans with their AVC pot. I’m quoting here from a guide given us by the Prudential.
Currently, from age 55, you have a number of options to choose from when you decide to take the money in your AVC pot. You may need to move your AVC pot to another pension to access some of these options or to access them when you prefer.
Take flexible cash or incomeYou can do this by moving your money into a drawdown plan. In most cases you can take up to 25% of your money tax-free, you’ll need to do this at the start. You can then dip in and out when you like or take a regular income. This may be subject to income tax.
Get a guaranteed income for life
You can buy an annuity – it pays you an income (a bit like a salary) and is guaranteed for life. These payments may be subject to income tax. In most cases you can take 25% of the money in cash, tax-free. You’ll need to do this at the start and you need to take the rest as income.
Cash in your pot all at once
You can take your AVC pot as a single lump sum. Normally the first 25% is tax-free but the rest may be subject to income tax.
Take your cash in stages
You can leave the money in your AVC pot and take out cash lump sums whenever you need to – until it’s all gone or you decide to do something else. You decide when and how much to take out. Every time you take money from your AVC pot, the first 25% is usually tax-free and the rest may be subject to income tax.
Leave your pot where it is
You don’t normally have to start taking money from your pot when you turn 55. It’s not a deadline to act.
Take more than one optionYou don’t have to choose one option – you can take a combination of some or all of them over time.
Now tax is the hard bit. You can of course take tax free cash from your defined benefit plan – but this means you have to swap pension for cash- like you do when you take a pension transfer. The exchange rate between cash and pension is down to what the trustees (advised by their actuaries) choose to offer you. Some may be generous and only charge you a pound of lifetime income to get £30 cash, some can be stingy and charge you a pound of lifetime pension to get £15 cash. It’s all down to what actuaries call commutation factors.
If you have a really generous set of trustees, they will let you use your AVC pot to fund your tax free cash meaning you don’t have to “commute” cash for pension. This is almost always a good thing to do.
The “almost” bit refers to AVCs which can be exchanged for an annuity at a preferential rate – what is known as a “guaranteed annuity rate” or GAR. If you see any mention of such things in your AVC literature you should check out what the GAR deal is with your pension manager or with the insurance company who offers the AVC (there should be contact details on the communication.
So what about this 25% tax-free cash option?
If you can’t swap your AVCs for tax free cash, (because the scheme rules don’t) allow, you can usually take your AVCs as a lump sum or transfer to a personal pension. In either case you should be able to get a quarter of your AVCs as tax free cash.
But you need to check with your scheme to make sure that you don’t fall foul of one of many very complicated bits of tax legislation that surrounds these old style pensions.
Where can I get help (that doesn’t cost an arm and a leg)
I don’t mean to sound biased but I strongly suggest that if you have any doubts about tax, you speak first to your scheme and see if they have advisers who can help you. Most do and most will allow you to understand the complexities of the situation using advice that is paid for – not by you – but by the trustees (and ultimately by your employer).
You can also get help from the Pensions Advisory Service that is now part of the Money and Pensions Service (MAPS).
Their pension helplines are open from 9am to 5pm, Monday to Friday.
They are available on webchat from 9am to 6:20pm.
Theye are closed on public holidays.
Pensions Helpline: 0800 011 3797
Overseas helpline: +44207 932 5780
Helpline for Self Employed: 0345 602 7021