Pension scheme trustees hold a significant responsibility in managing and safeguarding the retirement assets of their members, including Additional Voluntary Contributions (AVCs) paid by members to enhance their retirement benefits. With the many priorities and focus areas for Trustees, there's a risk of AVCs ending up low on the agenda and are not given sufficient attention and airtime at trustee board meetings. Not only is there a legal duty for trustees to ensure they govern their scheme AVCs effectively, but for many members, their AVCs are a valued and substantial part of their overall retirement savings.
Recent developments affecting pension schemes also impact AVCs. This article covers these developments and reinforces the reasons why trustees should keep AVCs on their governance radar. We also set out a structured three-step plan to help facilitate this process.
'Dashboard readiness' is becoming increasingly important as pension schemes connect to the ecosystem. The new dashboards will provide members with a holistic view of their overall pension savings, including AVCs. The trustee responsibility to ensure that their AVC arrangements are accurately captured on the dashboards becomes increasingly difficult where multiple legacy AVC arrangements exist. Early engagement with AVC providers and ensuring they are included in the wider dashboard project plan is crucial, noting that some legacy AVC providers may not be able to easily link with the ecosystem.
With increased transparency, members will be able to identify their AVC arrangements and access other details such as costs, charges and investment performance. This visibility may well generate more interest from members, particularly if they are making comparisons with other pension arrangements and conclude that the AVC charges and investment returns are not providing good value. There may also be gaps in AVC data, particularly for those legacy AVC arrangements; inaccurate or incomplete information can lead to member queries and complaints.
The winding up or buyout process is a significant undertaking with numerous workstreams feeding into the project. The complexities associated with many AVC policies means that considering these early in the process can help to avoid unnecessary delays and complications, which can be problematic during the buyout/wind up process. In particular, the potential loss of any guarantees on transfer (i.e. investment returns or annuitisation), penalties incurred on transfer (i.e. reductions in fund value) and loss of retirement options (i.e. using AVCs to fund the tax-free cash sum under the scheme) will need attention. Investments in with-profit funds can provide additional complexities and trustees may need to consider and quantify potential losses to compensate members for any loss of guarantees on transfer.
It is also essential to consider the quality of the member records and data. Incomplete or inaccurate data can present barriers as the receiving arrangement will be particularly interested in ensuring these are complete before taking on the responsibility for member entitlements. It is also common to find AVC accounts still operating for members who have already retired. Furthermore, some legacy providers can be unwilling to quickly engage with what is usually a complex project and documentation (including disinvestment processes) can be very outdated.
A thorough review of AVCs at outset can prevent unnecessary delays and protect members against potential negative impacts on outcomes.
Managing multiple legacy AVC providers can be costly and time-consuming. Trustees face considerable governance burdens, including monitoring investment options, performance, charges, guarantees and member communications. Simplifying AVC arrangements can streamline governance processes, reduce costs, and offer members better fund ranges, options and access.
With many schemes' funding positions improving, trustees now have the opportunity to use scheme surpluses to tidy up legacy AVCs (subject to their scheme rules). This can be achieved in a number of ways, including funding uplifts to AVC funds that incur a penalty or loss of guarantees on transfer or funding consolidation exercises to remove legacy AVC policies entirely from the scheme. By strategically utilising surpluses, trustees can simplify their AVC arrangements, reduce governance burdens and most importantly enhance member benefits.
The General Code came into force on 28 March 2024. While it does not address the Pensions Regulator's expectations in relation to AVCs explicitly, the Code requires trustees to ensure assets are invested in the best interests of members, and this also applies to AVC fund ranges.
The Code emphasises the importance of identifying, assessing and managing risks associated with a pension scheme. Trustees will be required to report on how they manage their scheme's governance and risks by carrying out an Own Risk Assessment (ORA) – with the earliest deadline for some schemes being March 2026. Schemes should consider how their AVCs comply with the expectations in the Code now, so they are well placed to report on the effectiveness of their system of governance in their ORA.
If trustees decide that managing their AVCs has become too burdensome, then they can explore alternative options, such as transferring to the DC Section of a hybrid scheme or to a master trust. Some alternatives may prove more attractive to members, particularly for legacy AVCs that provide poor value for members compared to more modern defined contribution arrangements.
To facilitate the governance of AVCs, safeguard member interests and meet trustee duties, a structured three-step plan can be followed by trustees:
01
The first step involves reviewing the AVCs held within the scheme. This includes identifying the investment options, charges, guarantees, and any other relevant details. A review should also include reconciling the membership, identifying any missing member data and documenting a clear understanding of the existing arrangements, highlighting areas that require attention.
02
Once the review is complete, trustees can consider any work needed to tidy up their AVC arrangements. The approach will vary by scheme, depending on the specific circumstances and design. Options may include consolidating providers or investment funds, renegotiating terms, or transferring AVCs to more favourable arrangements.
03
The final step is to document how the AVC arrangements will be governed going forward. Trustees should establish clear processes for monitoring and managing their AVCs in accordance with the expectations under the General Code. This ensures that AVCs remain aligned with the overall scheme objectives and continue to deliver value to members.
There are compelling reasons for trustees to ensure proper governance of their AVCs. This not only ensures that members' assets are managed effectively to provide optimal returns, but also ensures the trustees are well placed to meet their duties and are prepared for whatever the future holds for their scheme.
