Money: Don't trip up if you top-up

The Fixers

THERE HAS been a lot of comment recently about the merits or otherwise of taking out different types of top-up pensions. Many people champion those provided in-house by an employer and called AVCs, as opposed to those taken out privately through pension providers, such as insurance companies.

This is a simplistic view, however. No one type of top-up to a company pension scheme is right for everyone.

We recently saw a client whose case demonstrates all the different choices of topping-up a pension scheme. Jocelyn, 35, is a biology teacher earning pounds 18,000 a year. She has been in the Teacher's Pension Scheme since she started work a year ago. Clearly, Jocelyn needs to make some top-up to her pension scheme, having started her pension late.

Jocelyn could opt for topping-up the main scheme by buying "added years". She could take the in-house AVC, or she could choose her own free-standing arrangement.

She told us that she could pay pounds 100 per month top-up, which with tax relief netted down to pounds 77 per month.

First, we looked at the added years option. For Jocelyn, pounds 100 per month would buy her a little under eight years' benefit. This would mean that she would retire on an income, in addition to the main pension scheme, of an extra pounds 2,400 per year.

The advantage of buying added years is that this money would be safe and not subject to the ups and downs of investment performance. The downside is that if investments perform very well then you could be missing out.

We have to make reasonable estimates on what we feel investment performance is likely to be. In so doing, if we turn to investment AVCs with average charges, our projections show that at age 60, Jocelyn could expect an extra income, in today's terms, of about pounds 2,800.

The most interesting part of the analysis came when we looked at the in-house AVC. This showed a reduction in yield of 1.4 per cent for this client. A list of free-standing AVC charges showed a best reduction in yield of 1.1 per cent and the worst reduction in yield of 1.8 per cent. Of the 25 firms surveyed, two-thirds had a reduction in yield which was the same or better than that of the in-house scheme.

Jocelyn favoured a free standing AVC as it meant she could decide which company and which type of investment to go for. In-house AVCs have limited investment choice which may not be broad enough for an investor.

In addition, by choosing a pension of her own, Jocelyn could truly shop around. This is the sort of flexibility that she was looking for, and if she could have these choices without paying through the nose for them, she was happy to do something that was in her own control.

Not all choices are as straightforward as this one. Sometimes one is balancing the cheapness of an in-house AVC against the portability and choice of a free-standing AVC.

For those that find the choice difficult, it does not preclude them from taking both in-house and free standing AVCs, providing they don't exceed the overall maximum percentage.

Amanda Davidson is a partner at Holden Meehan, independent financial advisers (0171-692 1700)