Tax-Free Savings Survey: How to make the most of your pension

ARE YOU lucky enough to be in an occupational pension scheme? Some nine million of us are, but only a tiny fraction of these qualify for "maximum scheme benefits", where the amount paid at retirement is the most one is entitled to.

One way to make up any shortfall is by making additional voluntary contributions (AVCs) into your scheme.

Deciding whether or not you should be making AVCs depends on understanding how Inland Revenue rules are applied to the calculation of maximum benefits. The most important of these is that a pension scheme member can retire on a pension capped at no more than two-thirds of his or her final salary.

There are several definitions of what counts as final salary. It can be the average of the last three years' salary, the best year in the last 10 and so forth. However, according to Tony Reardon, the author of the Allied Dunbar Pensions Handbook: "Only a small minority of scheme members ever run up against the two thirds limit, because fewer and fewer of us stay in any one scheme long enough to qualify for them."

Most occupational pension schemes offer so-called "defined salary benefits". These calculate your pension entitlement according to the result of applying a fixed formula to the number of years over which you have been a scheme member.

A typical scheme might offer a maximum pension after 40 years of service; a term of employment that few, if any, of us are likely to complete with any single employer. So if you are in the scheme for only 20 years, you will qualify for no more than one third of you final salary.

Just as importantly, while the Inland Revenue puts an upper limit of two-thirds of your final salary on scheme benefits, it is wise to remember that particular pension schemes can offer lower rates of accrual than this. For instance, they may only offer maximum benefits, after 40 years service, of only half your final salary.

The exact details of how your scheme works will be given in its membership handbook, which should be available to you without charge. Contact your scheme trustees in writing, or try your trade union representative.

If you write to the scheme trustees you can also ask for a projected statement of your final pension benefits in the scheme. Again, this will be provided free of charge and should tell you clearly whether you are going to be short of years in the scheme.

The good news is that if you have had membership of several different schemes, the Revenue does not try to lump these together when deciding how much pension you are allowed. Each scheme, and your membership of it, is treated quite separately.

Occupational pension schemes are always either contributory or non-contributory.

The difference is simple; a contributory scheme requires an automatic deduction from you gross salary, along with contributions made by your employer.

So if you decide that you want to pay AVCs, a little care is needed in sorting out the maximum you can contribute in practice. The maximum allowable contribution is no more than 15 per cent of pensionable salary.

However any contributions you are already making to your main pension scheme, usually between 4 and 6 per cent of salary, are deducted from the 15 per cent allowance before you make any AVCs.

In practice, this will reduce the amount you can contribute to somewhere between 9 and 12 per cent of gross salary. You may also be paying premiums on "pension term assurance" within the 15 per cent allowance, and these must also be deducted to reach your final contribution allowance.

Your next important choice is between "in-house" or "free-standing AVCs" (FSAVCs) In-house AVCs are offered by the provider of your main pension scheme -usually a large insurance company - and pay no commission to intermediaries.

This means that they are cheaper than FSAVCs. Like-for-like, an in-house AVC should almost always give better returns. But the case against free standing AVCs is not open and shut.

Rules governing in-house AVCs mean that you must take benefit from them when you take benefit from the main pension scheme to which they are attached. They are not transferable or "portable" if you move from one pension scheme to another.

By contrast, FSAVCs are fully portable and can be "vested" or cashed in when you take benefit from any one of your pension schemes. In practice, this gives you greater flexibility about how you will ultimately take your pension benefits.

Just as importantly, FSAVCs offer a very wide range of fund choice, from "with-profits" to emerging markets - by contrast, typical in-house AVCs will usually only offer a with-profits fund or a managed equity fund.

"The problem," according to Andy Cox, of actuarial consultants Bacon & Woodrow, "is deciding whether or not any of these possible benefits will be of practical value to the great majority of those buying FSAVCs rather than the far cheaper in-house variety.

"Most pension scheme members would be better off with an in-house scheme. Most members do not have enough spare cash to use up their allowances for AVC contributions anyway, so every penny really counts."

According to Bacon & Woodrow, fund growth on in-house AVCs is on average 10 to 15 per cent higher than on FSAVCs as a result of their respective charging structures.