What are the best options for teachers forced to fund their own early retirement? Pensions experts suggest early routes out of teaching are available, but teachers should examine the alternatives very carefully.
Top of the list come free-standing Additional Voluntary Contributions (AVCs). The main advantages are that contri-butions are tax-free and the benefits can be taken at any age from 50 or deferred up to age 75, providing a teacher has left the profession. The disadvantages are the enormous variations in charges and terms.
"Teachers must take independent advice," warns Kevin Stratford of the independent financial advisers Berry, Birch and Noble. "Under some schemes, you could suffer penalties if you withdraw funds before the normal retirement age."
Charges will tend to be higher than for the teachers' AVCs managed by the Prudential, but the Pru scheme will not finance early retirement; you have to wait until 60 for the benefits. The best way to compare charges is to look at the "reduction in yield" figures which all quotations from an AVC provider or independent adviser have to show (see box). These figures give some indication of the charges incurred over the full term of the policy.
Flexibility is another important factor, according to June Easden, an independent consultant based in Bournemouth who specialises in teachers' pensions. "If your circumstances change, you might want to stop contributions for a while, so you might need a scheme which won't penalise you for doing this," she advises.
If you do think you may have to stop contributions at some stage, June Easden suggests investing a lump sum at the end of each tax year instead of making monthly contributions, as this will reduce any financial penalties.
It is also possible to avoid hefty charges early on by setting up a policy where the financial adviser's commission is spread over the whole term of the policy, rather than taken out at the beginning.
Charges for free standing AVCs can also vary considerably according to the amounts invested; some schemes will charge disproportionately more for smaller investments of below Pounds 50 a month, for instance.
"The charges may be higher than for the teachers' AVCs, but if it's the only way to achieve early retirement, then teachers need to weigh up the relative merits," says June Easden. She suggests that other ways of saving, apart from pensions policies, may also suit some teachers better, particularly if they will need to use the money in the short-term.
"Don't be too taken up by the tax advantages," she warns. "AVC funds have to be used to buy an annuity, and annuity rates are very poor at present." Although pension contributions are tax-free, the annuity itself will be subject to tax.
A Personal Equity Plan might offer more flexibility, as it does not have to be taken as pension. "PEPs could be useful to supplement part-time earnings, " comments Kevin Stratford. PEPs contributions are taxable, but the final sum is not.
"There's never one answer to suit everyone," insists June Easden. A unit-linked AVC fund may well offer a better long-term return than a with-profits scheme, but the chance of losing money is also greater, and many teachers may not want to take the risk.
REDUCTION IN YIELD - A USEFUL WAY OF COMPARING AVC CHARGES
The "reduction in yield" figure shows the effect charges will have on your investment.
To arrive at this figure, the AVC provider first calculates how much your contributions would earn once charges have been deducted at, say, 9 per cent interest accumulated over a given period. The provider then works out what interest rate would be necessary to accumulate the same sum without charges, say, 7.2 per cent. The difference between the two figures is the "reduction in yield".
"It's not a definitive guide but it is a good indicator of the differences in charges," says financial consultant Kevin Stratford, who points out that companies have different ways of calculating charges, and that they also need to predict accurately the changes in costs over the term of the investment.
June Easden, another independent consultant, says that considerations such as the credit rating and financial security of the company providing the AVC are just as important as the reduction in yield when you are choosing AVCs.
* For further information, contact: Berry, Birch and Noble, 0171 631 1919.
COMPARISON OF FSAVC PAYMENTS AND PEP INVESTMENT
Pension payments qualify for tax relief, so a payment of Pounds 150 a month by a basic- rate taxpayer would be increased to Pounds 197 once the tax relief is claimed. A typical plan might produce a fund of Pounds 62,000 over 15 years if the investment return is 9 per cent a year.
This fund must be converted into a lifetime pension - perhaps Pounds 470 a month for a man retiring at 55. After tax at 24 per cent this becomes Pounds 357 a month.
The same payments into a PEP which grows by 9 per cent a year might produce a fund of about Pounds 45,000. This would be tax free and have no restrictions, so a teacher retiring five years early could draw this fund over five years at approximately Pounds 833 a month, knowing that his teachers' pension will be starting when the PEP fund has all been used.