Your Money: How to keep mobile and build a good pension

A tangled career path can play havoc with your pension arrangements, but help may soon be at hand. John Andrew explains

Making provision for a decent level of income after retirement can be a nightmare. Company pension schemes are ideal because they are usually related to final salary rather than the performance of investment. Over a lifetime with one employer they can create a tidy sum. But even people who will enjoy a company pension can be lulled into a false sense of security.

To get the maximum entitlement allowed by the Inland Revenue - a pension of two thirds the amount actually earned in the final year at work - it is necessary to do 40 years of continuous service. Even then, the pension is usually a proportion of basic salary and not the total package enjoyed while working. Bonuses, large-town allowances and the value of perks such as a company car are ignored, which can come as a shock to the retiree.

Of course, to complete a lifetime's employment with the same company is the exception, not the rule. Early retirement, changing employers and career breaks generally mean a lower company pension.

People with a personal pension who change to pensionable employment may also suffer. It is usually wise to join the new employer's company pension scheme. But under present rules, such employees have only two options. They can either transfer the accumulated fund to the company scheme, or they can "freeze" their personal pension policy and make it "paid-up".

The latter course could well result in on-going charges being incurred. If the personal pension has flat-rate charges, it is also possible that these are greater than the rise in the value of the underlying investments, and instead of a pension fund that grows over the years, it will shrink.

The former alternative, the transfer of the personal pension fund to the new employer's pension scheme, may also be unacceptable, especially for employees who wish to stay mobile in the job market.

Fortunately, the Inland Revenue recently issued a consultation paper which proposes the introduction of a third option. This is the conversion of the personal pension to a free-standing additional voluntary contribution (FSAVC). In plain language, this is a personal top-up pension plan for employees in a company pension plan who wish to supplement their retirement income.

The conversion of a personal pension to a FSAVC will not only give greater personal choice, but will also give individuals more control over their pension fund and lead to a greater portability of pensions.

Unlike a personal pension, a FSAVC will not allow the provision of a lump sum of up to 25 per cent of the fund upon retirement. However, the Revenue is now proposing to allow those who transfer to ring-fence the personal pension element of their fund upon transfer and allow it to keep the advantages of a personal pension. At retirement, 25 per cent of the notionally segregated fund may be taken as a lump sum. It is proposed that the transfer option will be available from April 1997.

Anyone who is currently in a company pension should seriously consider contributing to a top-up pension anyway, either an Additional Voluntary Contribution to the company scheme or a FSAVC to a separate scheme, so that they can enjoy an enhanced standard of living in retirement. Some employers encourage staff to do so by matching their contributions into the top-up pension. The Government's incentive is to give tax relief on the contributions.

From the personalised Statement of Benefits given to members of the scheme each year, it is easy to ascertain the level of pension that will be payable at normal retirement age. If it is an option, the trustees of the fund will be able to advise the level of income at an earlier retirement age. Should your projected retirement income fall short of your needs, a top- up pension could be for you.

The Revenue considers a top-up pension to be part of the company pension arrangement and limits are imposed. However, there is a direct contribution limit and an indirect benefit limit. The maximum contribution that employees can make each year to a company scheme and a top-up pension is 15 per cent of their earnings from the company. The definition "earnings" includes bonuses, allowances and the value of perks. The pension payable from both schemes at retirement must not exceed two-thirds of the employee's earnings at retirement. The provider of the top-up pension will keep a check to ensure that it is not over-funded.

However, a FSAVC is not necessarily the best course. All company pensions are obliged to provide in-house top-ups, which are known as additional voluntary contributions schemes (AVCs). There are two basic type of AVCs.

The first links the benefits payable at retirement to the employee's final salary. The second and more usual route is a money purchase arrangement. This means that as with the FSAVC, the contributions are channelled into stock market investments or possibly cash deposits. At retirement, the fund that has been built up is used to buy an annuity. The retirement income from this route is dependent on the level of contributions, the performance of the underlying investments and the annuity rates at retirement.

lt is important to research whether a FSAVC or AVC is best for you. Approach your employer and obtain details of the in-house scheme. Many AVCs have charges that are lower than FSAVCs. Contributions are normally deducted from salary each month and tax relief is given at your highest marginal rate of tax. On the other hand, payments to a FSAVC receive tax relief at the basic rate with higher rate taxpayers claiming the additional relief from their Inspector of Taxes.

Some money-purchase AVCs offer little choice of funds into which contributions are paid and a few restrict the choice to just cash deposits. While the latter are secure, they do not offer the greater potential long-term growth associated with stock-market investments. On the other hand, final salary AVCs offer benefits that are predictable and not dependent on investment performance or annuity rates.

So, despite incurring higher charges than an AVC, the flexibility of an FSAVC may appeal to those who are likely to be mobile in the employment market in future years. An independent financial adviser will be able to guide you towards the best FSAVCs. However, at the end of the day, the choice between a FSAVC or AVC depends on your likely employment pattern.