What is an Additional Voluntary Contribution (AVC)
An Additional Voluntary Contribution (AVC) is a supplementary contribution made by an individual to their pension plan over and above the mandatory or regular contributions. AVCs are typically made to employer-sponsored pension schemes or Personal Retirement Savings Accounts (PRSAs). The primary purpose of AVCs is to boost an individual’s retirement savings and secure a more comfortable financial future. By making AVCs, individuals can take advantage of the tax relief and long-term growth potential associated with pension contributions, thereby increasing their retirement income. If affordable, making AVCs can be a wise financial decision for individuals seeking to maximize their retirement savings and improve their financial security in retirement.
Advantages of Additional Voluntary Contribution (AVC)
AVCs offer several benefits, including:
Accelerated retirement savings growth
By making AVCs, individuals can benefit from the power of compounding interest, which allows their retirement savings to grow more rapidly over time. This growth can help individuals reach their retirement savings goals more quickly, ensuring a comfortable retirement.
Tax benefits
Depending on the jurisdiction and the type of pension plan, AVCs may be eligible for tax relief at the individual’s marginal rate, up to certain limits. This tax relief effectively reduces the cost of saving for retirement, making AVCs an attractive option for individuals looking to boost their retirement savings in a tax-efficient manner.
Catching up on missed contributions
Individuals who have not consistently contributed to their pension plans, have taken a career break, or have started saving for retirement late in their careers may use AVCs to catch up on missed savings and improve their retirement prospects.
Enhanced retirement benefits
AVCs can provide a more significant retirement income or a larger tax-free lump sum at retirement, depending on the pension scheme rules and the individual’s preferences. This additional income can be essential in maintaining a comfortable standard of living during retirement.
Flexibility
AVCs can be made at any time and can be adjusted or paused as the individual’s financial circumstances change. This flexibility allows individuals to make additional contributions when they can afford to do so, without being locked into a fixed payment schedule.
Why make AVCs?
Given the long-term nature of pension investments and the potential impact of market fluctuations on the value of retirement funds, it is essential to make AVCs if you can afford it. Here are some reasons why making AVCs is important:
Longer life expectancy
With advancements in healthcare and technology, life expectancy is increasing, leading to longer retirements. Making AVCs can help ensure that individuals have adequate retirement savings to last throughout their retirement years, reducing the risk of outliving their savings.
Lower guaranteed pension benefits
Many employers are moving away from defined benefit pension plans, which provide a guaranteed retirement income, to defined contribution plans, where the retirement income depends on the investment performance of the pension fund. By making AVCs, individuals can help bridge the gap between the income provided by their pension plan and the income they need to maintain their desired standard of living in retirement.
Inflation risk
Inflation can erode the purchasing power of retirement savings over time, leading to a lower standard of living in retirement. Making AVCs can help counteract the effects of inflation by increasing the individual’s retirement savings and ensuring a more significant retirement income.
Market volatility
Pension investments are subject to market fluctuations, which can impact the value of retirement funds. Making AVCs can help offset the impact of market volatility on an individual’s pension plan by providing a more substantial buffer of savings.
Reduced reliance on state pensions
State pensions may not be sufficient to maintain an individual’s desired standard of living in retirement. By making AVCs, individuals can reduce their reliance on state pensions and ensure a more comfortable retirement.