Summary

AVCs can increase UK retirement income in several ways: by building a separate money purchase pot, by enhancing the tax-free cash lump sum from a workplace scheme, by funding an Annuity, or by providing flexi-access drawdown after transfer. Each route has different income, tax and longevity implications.

The case for AVCs strengthens for higher-rate taxpayers, for employees near retirement with unused tax-free cash capacity in a defined benefit scheme, and for those with access to salary sacrifice. The case weakens where competing priorities such as Debt repayment, Mortgage clearance or insufficient emergency savings dominate.

This article shows how AVCs work mathematically in the 2025/26 tax year, using the standard Annual Allowance of 60,000 pounds and the Lump Sum Allowance of 268,275 pounds, with examples reflecting public sector and private sector workplace schemes.

This article is informational only and not financial advice.

Key Takeaways

• AVCs build a separate DC pot inside a workplace pension to supplement main scheme benefits.
• Tax relief at marginal rate boosts the effective contribution by 20%, 40% or 45% before Investment growth.
• AVCs can be used to maximise tax-free cash from a DB scheme without commuting DB pension.
• They can fund an annuity for guaranteed extra income, or be transferred to a SIPP for drawdown.
• Compounded investment returns over a working lifetime can materially increase retirement income.
• The MPAA of 10,000 pounds limits future DC contributions once flexible access is taken.
• The Annual Allowance, Lump Sum Allowance and access age all shape the eventual benefit.

How Additional Voluntary Contributions Can Increase Retirement Income

For UK employees who want to increase their retirement income, Additional Voluntary Contributions remain one of the most efficient tools available. They sit inside a workplace pension scheme, attract income tax relief at the saver's marginal rate, and produce a flexible money purchase pot alongside any defined benefit or defined contribution main pension.

In the 2025/26 tax year, the framework that shapes how much extra income an AVC can buy includes the 60,000-pound Annual Allowance, the Lump Sum Allowance of 268,275 pounds, a Normal Minimum Pension Age of 55 (rising to 57 from April 2028) and the 10,000-pound Money Purchase Annual Allowance for those who have already accessed a DC pot flexibly.

This article explains how AVCs can lift retirement income in practice. It looks at the tax relief mechanics, the choice of investment strategy, the four main retirement Options for an AVC pot, and the trade-offs around timing, tax allowances and the State Pension. The aim is to give a clear framework rather than to recommend a level of contribution.

The tax relief boost on every AVC pound

The most predictable element of an AVC's contribution to retirement income is the tax relief it attracts at the point of contribution. A basic-rate taxpayer paying 100 pounds from net pay sees a gross contribution of 125 pounds land in the AVC pot; a higher-rate taxpayer's net 60 pounds becomes 100 pounds; an additional-rate taxpayer's 55 pounds becomes 100 pounds.

In public sector net pay arrangements the relief is given automatically because the contribution is deducted before income tax is calculated. In salary sacrifice arrangements such as the LGPS Shared Cost AVC, employee National Insurance at 8% in 2025/26 is also saved on the sacrificed amount, increasing the effective uplift.

Tax relief is the single largest reason AVCs typically outperform equivalent contributions to an ISA on a like-for-like basis when measured at retirement, although the tax treatment is reversed at decumulation - pension income above the 25% tax-free element is taxable, while ISA withdrawals are not.

How investment growth compounds the contribution

Once paid in, AVCs are invested in funds chosen by the member from the scheme's range. Over a working lifetime, the compounded effect of even modest annual contributions is significant. A 200-pound a month gross AVC over 20 years at a real return of 3% per year before charges would produce a pot in the region of 65,000 to 70,000 pounds in today's money, illustrative of order of magnitude only.

The investment strategy is a critical decision. Lifestyle defaults typically reduce Equity exposure as retirement approaches, lowering Volatility but also potential returns. Self-select investors can keep more equity exposure for longer, accepting higher short-term volatility. There is no single right answer; the appropriate balance depends on time horizon, Risk tolerance, other Assets and the role the AVC pot will play at retirement.

Charges matter. A difference of 0.3% per year over 25 years can reduce the final pot by several percentage points. Members should compare the AVC scheme's charges with those of any alternative SIPP and review fund factsheets annually.

Using AVCs to maximise tax-free cash

For defined benefit scheme members, the most common income-boosting use of an AVC is to fund the 25% tax-free cash entitlement, leaving the full annual DB pension intact. Without an AVC, taking the full tax-free cash typically requires commuting DB pension at scheme-specific rates that are often less generous than the open-market actuarial value.

In the LGPS, members can take up to 100% of an AVC pot as tax-free cash, provided total tax-free cash is within 25% of the combined value of DB benefits and AVC pot and within the 268,275-pound Lump Sum Allowance. The same principle, with scheme-specific wording, applies in NHS MPAVCs, Teachers' AVCs and Civil Service AVCs.

For a worked example, an LGPS member with a 15,000 pound a year DB pension at retirement might have a combined benefit value (using HMRC's valuation method) of around 315,000 pounds at typical commutation factors. A 25% tax-free cash entitlement of about 78,750 pounds could be drawn entirely from an AVC pot up to that size, leaving the 15,000-pound DB pension untouched.

AVCs as a source of additional income - annuities and drawdown

Beyond tax-free cash, the AVC pot can fund extra retirement income in two main ways. The first is to buy an annuity, either inside the scheme (where available) or on the open market under the Open Market Option introduced by the Pensions Act 1995. Annuity rates depend on age, health, gilt yields and product features; lifetime annuity rates have risen substantially since 2022.

The second is to use flexi-access drawdown. Most AVC arrangements do not offer in-scheme drawdown directly, so the residual pot after tax-free cash is typically transferred to a personal pension or SIPP. The saver then takes income flexibly, subject to income tax at marginal rate on the taxable portion.

A blended approach - taking some tax-free cash, buying a small enhanced annuity for guaranteed core income, and using drawdown for flexible top-up - is increasingly common. The right mix depends on longevity expectations, attitude to investment risk in retirement and the level of guaranteed income from the State Pension and any DB scheme.

Timing AVCs effectively across a career

The income-boosting power of an AVC depends partly on when contributions are made. Early contributions get more time to compound; late contributions concentrate tax relief at the highest marginal rate, particularly for senior employees crossing the higher-rate or additional-rate thresholds.

A common pattern is to begin modest AVCs early - perhaps 1% to 3% of pay - to build the habit and exploit compounding, then increase contributions sharply in the final five to ten years of work when income is highest, the mortgage is cleared and dependants have left home. This approach also takes advantage of unused Annual Allowance via Carry Forward.

Carry Forward allows unused Annual Allowance from the three previous tax years to be added to the current year, provided the member was in a registered pension scheme in those years. For a public sector employee with relatively low pension input in early career, this can permit a much larger late-career AVC than the 60,000-pound standard limit would suggest.

Interaction with the State Pension and tax bands

AVC retirement income should be planned alongside the State Pension. The new full State Pension is 230.25 pounds a week in 2025/26, equivalent to about 11,973 pounds a year, and is taxable. With the personal allowance frozen at 12,570 pounds, a basic-rate taxpayer drawing income from a DB pension and AVC drawdown can quickly find more of the AVC Withdrawal taxed at 20% or 40%.

This makes spreading AVC withdrawals across tax years often more efficient than taking large lump sums of Taxable Income in a single year. Combining tax-free cash with phased drawdown can keep marginal tax low for many retirees.

For those still working past State Pension age, AVCs remain available, and contributions can continue to attract tax relief up to age 75. Care is needed once any flexible access has been taken, because the MPAA of 10,000 pounds then caps further DC contributions, including AVCs.

Risks and downsides to consider

AVCs are pensions, so the money is normally locked away until age 55 (57 from April 2028). They are exposed to investment risk; pot values can fall as well as rise, and any annuity bought later depends on the rates available at the time.

Tax rules can change. The Lump Sum Allowance, Annual Allowance, MPAA and Normal Minimum Pension Age have all been amended in recent years; future Budgets may amend them again. The Office for Budget Responsibility regularly highlights pensions tax relief as one of the largest reliefs in the UK tax system.

AVCs are not the only way to lift retirement income. For some savers, paying down debt, building emergency cash savings, increasing main-scheme contributions (where matched by employer), or using an ISA may be a higher priority. A structured plan, ideally with MoneyHelper guidance or FCA-authorised advice, helps weigh these options.