Personal Pensions & AVCs
If you are self-employed or your employer doesn’t pay into a pension scheme, putting money aside through a personal pension plan be it a PRSA or traditional Retirement Annuity contract makes perfect sense. You can certainly save without using a pension structure but you will be missing out on the generous tax benefits.
Similarly if you are in a company pension scheme and want to add to your fund, Additional Voluntary Contributions (AVCs) are the way to go.
As people are now living longer and longer, a larger pension fund than ever before is required to ensure you can enjoy the comforts in retirement that you have become used to whilst working. With full tax relief available at your highest tax rate, and PRSI relief, AVCs are an extremely cost effective way to improve your financial status in retirement. You can make regular contributions, say monthly, or you can pay a lump sum on a once-off basis. It can also be possible to nominate a contribution to the previous tax year and get the tax back.
The portion of your fund attributable to AVCs qualifies for the beneficial ARF options at retirement (see section on ARFs below).
The two scenarios below illustrate why the savings structure you use is so important.
Example 1:
Bill has decided to save €150 a month from his take-home pay for the next 5 years in a deposit account yielding 4.5% per annum gross.
Total Amount Saved |
€ 9,000 |
Example 2:
Had Bill taken a different approach and saved through his pension fund the outcome would be dramatically different. For the same reduction in his take-home pay of €150 a month he would have got the benefit of €254.24 a month because of tax relief (regrossed to account for 41% tax relief). The picture after 5 years and allowing for the same 4.5% yield would be as follows:
Total Amount Saved |
€ 15,254.24 |
These examples are simply to illustrate the tax benefit of a pension structure and they do not take account of the fact that the pension fund money will only be accessible at retirement and that tax may be incurred on the sum at retirement depending on choices made at the time.
The Cost of Delaying
A salutary tale…
Aisling and Breda, both aged 20, start work together on the same day and on the same pay. They share the same apartment and split their expenses equally. During the first month at work, they attend a presentation in work where they learn about the benefits of taking out a PRSA
Aisling decides to sign up and her contribution of €50 a month is matched by the same amount from the company. After tax relief it cost Aisling €37 a month. Breda, however, wants to wait until she is older before starting to save. Allowing for pay increases and a return on savings of 6% a year Aisling accumulates €24,800 after 10 years. Seeing this Breda now aged 30 decides to join the scheme. By the age of 60, Aisling’s retirement account would be about €400,000, while Breda’s account balance, started 10 years later, would be about €266,000.
Tax relief on contributions
You get tax relief on contributions to approved personal pension arrangements. This relief is more generous as you get older.
Age |
Percentage |
Under 30 years |
15% |
The maximum rate also applies to people in certain occupations and professions, irrespective of age where there is a limited earnings span. These occupations include professional athletes.
There is a ceiling of 254,000 euro on the earnings that may be taken into account. This limit will be increased in line with earnings from 2007.
You no longer have to buy an annuity with the proceeds of your pension policy, however, you may do so if you wish. This option does not apply in general to occupational pensions, but it may apply to the Additional Voluntary Contributions (AVCs) paid by people in occupational pension schemes.
Limit on overall value of fund
The Finance Act 2006 introduced a limit on the value of an individual's pension fund which may attract tax relief. The limit is the amount in the individual's pension fund on 7 December 2005 or 5 million euro whichever is the greater. This will be adjusted annually from 2007. If the fund is greater than the limit then tax at 42% will be charged on the excess when it is drawn down from the fund.
Transfer between funds
You do not have to remain in the same pension fund. You may transfer funds accumulated with one insurer to another fund with another insurer. Of course, there may be costs involved in doing this.
When you retire, you may opt for the existing annuity arrangements or for the new arrangements. The new arrangements mean that the accumulated fund is your property. You must take your pension not later than your 75th birthday (the previous upper limit was 70).
Approved Minimum Retirement Fund
You may take up to 25% of the fund as a lump sum (tax-free). Then you must set aside at least 63,486.90 euro of the fund and place it in an Approved Minimum Retirement Fund (AMRF). This fund may not be drawn down to less than 63,486.90 euro until you reach 75. This obligation to invest in an AMRF will not be imposed if you have a guaranteed pension or income for life from a state pension, annuity or occupational pension of at least 12,697.38 euro per annum (this is called the minimum income requirement).
Approved Retirement Fund
After investing in the AMRF, you can then simply take the balance of the funds or you may invest them in an ARF or a number of such funds. If you take the funds, you will, of course, have to pay tax on them. An ARF can be any fund, including a bank account, in a regulated financial institution. Income tax is payable if you draw down these funds.
From 2007-2009 a tax on those parts of the fund which are not drawn down will be phased in. The tax will be 1% in 2007, 2% in 2008 and 3% from 2009 onwards and will apply to ARFs created on or after 6 April 2000.
After death
If you die before taking any benefit from your fund, the accumulated funds form part of your estate and are distributed accordingly. Capital Acquisitions Tax may apply.
If you die after taking benefit and you have invested in an ARF, the remaining funds form part of your estate but are regarded as your income in the year of death. Tax at your marginal rate is deducted and the remaining amount is distributed in the normal way. There is no CAT liability. However, if your spouse inherits the funds, no income tax is payable. Effectively, your spouse steps into your shoes as owner of the fund and when he/she dies, a 20% rate of income tax may be payable and there is no CAT liability. This is the case unless the funds are inherited by children over 21 - in this case, the amount they get is taxable as the child's income in that year, but taxed at a flat rate of 20% rather than at the child's marginal tax rate.