Investment: the pounds 12,000 question

IN addition to my final salary company pension scheme, my employer operates an AVC (additional voluntary contribution) scheme with Equitable Life. As a higher-rate taxpayer with 15 years before retirement, is it better to pay money into the AVC pension fund, saving tax, or to receive the bonus net of tax and invest it in PEPs for myself and my spouse? I will shortly be receiving a salary bonus net of pounds 12,000 before tax and am wondering where to invest it.

HB, Bedfordshire

You should try this question out on some independent financial advisers. The choice is not clear cut. Here are some thoughts:

q Ask your pensions administrator for a projection of your likely company pension. If you are already heading for quite a decent pension, that could tip the balance in favour of PEPs (or their successors next year, individual savings accounts).

q You can pay no more than 15 per cent of your gross salary into the company pension/AVCs in any one year. So, depending on your earnings, you may not be able to invest your lump sum bonus into AVCs in one go.

q AVC contributions are worth more than PEP contributions because they come from your gross pay. You get tax relief on contributions.

q On the other hand, any income from share-based PEP investments is boosted by the 20 per cent tax credit (10 per cent from next April) that accompanies share dividends. You can no longer claim this tax credit on investments held within pension/AVC schemes.

q AVCs are much more inflexible than PEPs. You will be forced to take your money in the form of a pension annuity at the time you take your main company pension (with the exception that regular AVC contributions that started before 8 April 1987 can be partially taken as a lump sum).

q The income from a pensions annuity is fully taxable. By contrast, you can draw a tax-free income from a PEP.

q You'll need to consider how charges on the AVC and a PEP compare.

q All this is subject to the caveat that the rules on ISAs and pensions, PEPs and ISAs themselves, and tax rates and investment returns in relation to annuity rates could change in the next 15 years before you retire. Only on retirement, with the benefit of hindsight, will you know whether AVCs or PEPs were the better option.

The flexibility of PEPs could be the clincher, whatever the different projections of benefits look like. But if you ever had to resort to any means-tested benefits before retirement, PEPs are assets that would be taken into account when assessing means.

q Write to the personal finance editor, 'Independent on Sunday', 1 Canada Square, Canary Wharf, London E14 5DL and include a phone number, or fax 0171-293 2096. Do not enclose SAEs or any documents you wish to have returned. We cannot give personal replies or guarantee to answer letters. We accept no legal responsibility for advice given.