Go the extra mile for your pension plan

Decide against joining your employer's main pension scheme and you are probably turning down a potentially valuable part of your overall remuneration. But is the same true of those second-rung employers' plans, additional voluntary contribution (AVC) schemes? The decision is more finely balanced.

Additional contributions are made by employees who realise that their company pension is likely to fall short of the maximum allowed by the Inland Revenue, which is two-thirds of your pay at retirement. In fact most members of employer schemes are likely to find their pension is below the maximum. Many would gain from extra payments.

People in company schemes can get tax relief on up to 15 per cent of their pay in respect of pension contributions. So if you pay 5 per cent to the main scheme, you can pay up to 10 per cent of before-tax pay in AVCs.

But there is a choice of such schemes. You can use the scheme for additional contributions run by the employer, or choose one run by an outside provider, a free-standing plan (called FSAVC). These are offered by insurance companies, unit and investment trust managers, building societies and banks.

Conventional wisdom says an in-house scheme is better because less money is lost in charges. But there can be problems. For example, a scheme whose underlying investment is building society deposits is relatively low risk and may be suitable for people within five or 10 years of retirement. But younger people making additional contributions may get bigger returns from higher-risk stock market schemes.

So before committing your money, find out how the in-house scheme works. AVC plans are often quite separate from a company's main pension scheme. The eventual pension income it gives is likely to be based on both the investment performance of the fund and annuity rates at the time the fund is converted to a pension income. This is often the case even if the main scheme is based on a formula linked to pre-retirement pay and guaranteed on retirement. But some employers allow AVCs to buy extra years' membership of the final pay-linked scheme. This can be a worthwhile perk.

In its most recent annual survey of employer-run AVC schemes, Bacon & Woodrow, a firm of actuaries, listed five factors an employer should look for in its AVC scheme provider. First, its financial position and prospects, especially where plans based on "with-profits" investment are involved. Next, a simple and transparent charging structure. Third, a range of investment options. Fourth, a high standard of service. Finally, does the provider have a long-term commitment to the AVC market?

There is no reason why employees should not use the same criteria when assessing the relative merits of an in-house and an individually chosen (FSAVC) plan. Ask your pensions administrator how the in-house scheme measures up to the five criteria. If you get a positive response, you may well have an employer who has paid proper attention to the AVC plan. But if you encounter a blank expression, be wary.

AVC schemes based on bank and building society deposits remain popular even though they are probably unsuitable for younger employees. A decent AVC scheme will offer a choice of investment options, allowing younger employees to switch into a safer, deposit-based plan as retirement approaches. AVC plans can come in various forms: with-profit and unit-linked investment funds and deposit accounts. The first two are generally based on a spread of assets that include shares. These give the prospect of better returns in the long run but in the short term may do worse.

Next week: child benefits.