"The next big pensions scandal is likely to be the selling of free-standing AVCs," says Susan Johnson, head of pensions at the Association of Teachers and Lecturers. The union is becoming concerned at the increasing number of its members asking for help after being sold an unsuitable AVC package.
AVCs can be used to top up a pension so that teachers can end up with benefits equivalent to those they would receive after 40 years' service with the Teachers' Superannuation Scheme at age 60. Free-standing AVCs can be purchased from insurance companies, unit trusts and building societies, although the ATL suggests that most teachers wanting to buy AVCs would be better off with the in-house scheme run by the Prudential.
The main complaint about most free-standing AVCs is the high administration charges, about 20 per cent for a free-standing AVC, compared with only 1 per cent for the Prudential AVC scheme.
"Some teachers have only become aware of the high charges involved in free-standing AVCs after they have bought into a scheme," said Marion Bird, deputy head of pensions at the ATL. "They are horrified when they discover that the Prudential's charges are only 1 per cent."
The best way to compare the charges is to ask the free-standing AVC-provider to produce a table of transfer values. This shows the amount you would have available to take to another provider during the first five years. In many cases, even after five years, the fund available is still less than the amount that has been paid in. You should also find out the cost of buying one added year and compare it with the amount you need to pay by way of AVCs to produce the same benefit.
Inaccurate advice from providers of AVCs is another problem. "Getting the commission seems to be more important than giving the correct advice," commented Marion Bird.
Mrs Bird was recently contacted by a teacher who was appalled to learn that she would not be able to use her AVC to pay off her mortgage when she retired, as she had been assured by her AVC-provider. AVCs have to be used to buy an annuity.
Another common misconception is that you can defer the purchase of an annuity until the market conditions are right. In fact, an annuity must be bought immediately, no matter how low the current interest rate.
Some teachers have also been misled into thinking that they could use their AVCs to take early retirement. The Teachers' Pensions Agency rarely pays out from the Teachers' Superannuation Scheme to anyone who wants voluntary early retirement before 60 (see Personal Finance, TES, May 31, 1996). The proceeds of AVCs will not be paid until benefits from the TSS are due, so they cannot be taken early, either.
One of the main advantages of free-standing AVCs is that they are portable, but as most teachers tend to stay in the profession, this is of little benefit.
The ATL is urging members to look carefully at all the options if they want to boost their pensions. For many teachers, purchasing additional years of past service could be the best way to improve their pension. According to Marion Bird, this method is not as expensive as some teachers fear. A 35-year-old teacher purchasing four additional years' service, for instance, would pay 3.24 per cent of her salary over 24 years; when you take tax relief into account, this amounts to just under 2.5 per cent of her salary. You can pay with a lump sum, but this reduces the tax benefits.
The main advantage of past added years is that you know what you're getting. Each past added year guarantees 180 of final salary as pension, plus 380 of salary added on to their tax-free lump sum. AVCs' value depends on the annuity rate prevailing when you retire and the investment return once expenses have been deducted, as well as on your level of contributions.
For teachers taking early retirement through ill-health, who made up one quarter of all retiring teachers last year, the past added years route has a huge advantage.
If you have already undertaken to buy past added years, you and your dependants will get full credit for these, no matter how long the payments were set to continue. This also applies if you die in service.
Bacon and Woodrow, a firm of consulting actuaries, recommends that teachers who still have at least 10 years to go before retirement should definitely consider the added years route, particularly if they are expecting substantial promotion in the future. You could be paying relatively cheaply now for handsome benefits in the future. Those who are nearer to retirement should look at the AVC option.