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MONEY Q&A: What's the best way to save for retirement?

I am 42 years old and have been teaching since 1978. My salary is around pounds 28,000. As well as my basic contribution to the teachers' pension scheme of pounds 130 a month I have been paying the same percentage of my pay in AVCs (additional voluntary contributions) since 1992. I am hoping to retire when I complete 35 years' service. Is paying AVCs the best way to save for retirement?

PD, Herefordshire

Not necessarily. You could consider a tax-free ISA instead. The ISA investment limits of pounds 7,000 in the 1999-2000 tax year and pounds 5,000 in subsequent years are more than enough to accommodate the money you are currently paying in AVCs. Indeed, the combined pension/AVC contribution limit for those in an employer's pension is 15 per cent of gross pay. So pounds 5,000 a year into an ISA would allow anyone earning up to pounds 33,333 to exceed that 15 per cent limit. However, the case for paying AVCs is stronger once you are into the higher-rate tax bracket.

The AVC versus PEP/ISA argument has become more acute in the last year or two after a change in tax perks and the collapse of annuity rates. Indeed, there is even a debate as to whether an ISA could be better than a personal pension. To reassure you, there is still little doubt that an employer's final-salary pension scheme, especially a public-sector one, will nearly always be the best way to spirit away money for your retirement years.

But AVCs are a different matter. The problem with AVCs is that they are inflexible. You cannot access your money until retirement (although the rules are due for some easing). You have to use the money saved to buy an annuity, (although some schemes, including the teachers' pension scheme to a limited extent, allow you to buy valuable added years' membership of the main scheme). Annuity rates have plummeted and could stay low for a generation. What is more you cannot take part of an AVC fund as a lump sum (unless you started making AVCs before April 1987).

By contrast, you can do what you like when you like with funds in an ISA. This does have the possible drawback that you may be tempted to access the money before retirement if you are not disciplined. It also means that if you are unlucky enough to have to claim means-tested state benefits before retirement, funds in an ISA will be taken into account, unlike funds in pension or AVC schemes.

Then there's tax. The big advantage of pension and AVC contributions is that you get tax relief on what you pay. For a higher-rate taxpayer, each pounds 1 deducted from gross pay for AVCs in fact costs only 60p. That's quite a benefit for higher-rate taxpayers. But pounds l costs a basic-rate taxpayer more in net contribution - 77p, rising to 78p next year when the basic- rate of tax falls. By contrast, you get no tax relief on ISA contributions. However, you will be able to withdraw a tax-free income from an ISA when you retire whereas all annuity payments are fully taxable.

Pension (and AVC) funds, can no longer boost their assets by claiming back a tax credit on dividend income from share-based investments. By contrast, similar investment income within an ISA will benefit from a 10 per cent tax credit for the next five years (although probably not after 5 April 2004).

Making the decision whether to put money into AVCs or an ISA is not an easy one. And it's further complicated by the ever-changing rules on pensions, AVCs and tax-free investments such as ISAs. You cannot know what will happen over the next 15 to 20 years. However, the sheer flexibility of ISAs will probably be the deciding factor for many people.

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; or e-mail i.berwick@independent.co.uk. Do not enclose SAEs or any documents you wish to be returned. We cannot give personal replies, nor can we guarantee to answer letters. We accept no legal responsibility for advice given.