For a fuller retirement

Pensions:Topping up

Of all the employees in company pension schemes, only one in 10 retires on the full amount of pension allowed by the Inland Revenue. Likewise very few people who are currently investing in a personal pension plan are putting in the maximum amount permissable under Revenue rules.

Most people leave saving for their retirement too late. By the time they start thinking about putting some money away, they actually need to save hundreds of pounds a month to sustain the kind of lifestyle they have in mind. And company schemes do not make full use of contribution limits.

However, provided they have cash to spare, there are several tax-efficient ways to top up their pension.

All companies with pension schemes must, by law, offer an additional voluntary contribution scheme (AVC) for members of the main pension scheme. An AVC is run as a separate fund to the main pension scheme, and its management may be farmed out to a third party - a life office or building society. It enjoys nearly all the same tax breaks as the main pension scheme - members' contributions are taken from their pay before tax, given relief from income tax at their highest rate, and contributions grow tax-free within the fund.

Many employers subsidise the management charges, making the AVC a very cost-effective way to invest - most, if not all, of the contributions will be invested for the benefit of the employee. Contributions are paid net of basic-rate tax. This means that for every pounds 100 the investor wishes to contribute to his AVC, he pays pounds 75 and the insurance company claims the remaining pounds 25 from the Inland Revenue. Higher-rate taxpayers must claim any further relief through their tax returns.

It is also possible to choose your own top-up policy, which is known as a free-standing AVC. FSAVCs are sold by insurance companies on a commercial basis, and are not subsidised by the employer, so charges can seem high in comparison to an AVC.

Members of company schemes can contribute up to 15 per cent of their total remuneration - basic salary plus any bonuses and commission - into pension schemes, including an AVC or FSAVC. So if a scheme member is already contributing 5 per cent of his earnings to the main pension scheme, he could put a further 10 per cent into an AVC.

AVCs are simple money-purchase schemes. The money an employee invests plus any growth is used to buy an income annuity at the time of retirement. However, the best way to top up an occupational pension is not with an AVC but through buying "added years". This option is usually only open to members of "final-salary" public sector pension schemes, but some private company schemes have also adopted this approach.

Each year that an employee belongs to a final-salary scheme entitles him to a portion of his final salary as retirement income. For example, he might belong to a scheme that pays him 1/80th of his final salary for every year.

The advantage of buying extra years is that although the employer can estimate the effect of inflation on the value of an employee's salary over the period to retirement and charge accordingly, the company cannot predict salary increases that result from promotion. This means the employee can benefit from a substantially higher retirement income without having to pay for it.

Self-employed investors and employees who are not able to join a company pension scheme should make the most of investing into a personal pension. Very few people invest as much as they can into personal schemes - from 17.5 per cent of net relevant earnings for anyone aged 35 or less to 40 per cent for those aged 61 to 74.

If an investor has used up the current year's allowance, he should be able to mop up any unused allowance and tax relief from the previous six years - a process known as "carry forward". This means that if a 35-year- old investor only used 10 per cent of his allowance six years ago, he can contribute the remaining 7.5 per cent now on top of this year's allowance.

Investors can also "carry back" contributions to the previous tax year. This allows the contribution to be treated tax-wise as though it had been paid into the pension scheme in the preceding year - a process that can help those who are trying to minimise their income tax bill.

Both carry forward and carry back are extremely complicated, and anyone interested in pursuing these options should consult an accountant or pensions adviser.

Richard Jacobs of Richard Jacobs Pension and Trustee Services says investors who want to maximise the flexibility of their retirement arrangements should also invest in personal equity plans. He argues that Peps offer equivalent tax advantages but unlike pensions - which only pay out at retirement - capital and income can be withdrawn from a Pep at any time. "This makes them ideal for the one-off expenses that can occur at any time, or to supplement a pensioner's income until he reaches state pension age," he says.

Bill Lane and his wife Sally are both topping up their company pension schemes so they have the option to retire at the age of 50. Bill, a 35-year-old computer salesman, earns a basic salary and commission. His company pension scheme contributions are based on the basic wage plus half his on-target commission earnings. As he regularly earns in excess of his target, Bill was worried that his pension would not reflect his current income.

Bill's company offered just one AVC scheme which did not suit his needs, so he has chosen a free-standing AVC from Skandia Life. The scheme's investment projections indicate that it has the lowest charges, and it offers the choice of more than 200 funds, managed by the UK's leading investment houses. He is currently paying contributions of pounds 250 a month.

Despite the extra contributions, Bill is still not saving enough to be able to retire on the income he would like at the age of 50. He says: "I'm still well short of the target, but I'm also investing the maximum amount possible in Peps, and was a heavy investor in business expansion schemes."

Sally, at the age of 29, is unusually young to be topping up her pension. She wants to invest as much as she can now in case she needs to take a career break to have children.

Her employer, Marks & Spencer, runs a final-salary scheme that allows members to buy added years. Sally has bought 10.6 extra years, at the cost of pounds 120 a month.