Lump sum query - can you use AVC to boost your lump sum?

[trident]

Hi all,
My understanding is that the lump sum received is tax-free up to €200,000.
My question is:
If someone is on €100,000 per annum then their lump sum will be €150,000.
They have an AVC which will be worth about €100,000 upon retirement.

Can they use €50,000 of this AVC to bring their tax free lump sum up to €200,000 ?

Thanks in advance for any advice.
Regards,
T

 

[Conan]

No.
The Revenue limit is that the max lump sum is 150% of Final Salary (or 25% of the fund value in D.C. Schemes) subject to having completed at least 20 years service by retirement. Whatever lump sum is payable, the first €200k is tax free . So if Salary is less than €133,000, then you cannot get a lump sum of €200k.

 

[trident]

Hi Conan. Thanks for the reply. So, someone on €100,000 could draw down a lump sum of €150,000. However, if they have an AVC worth €100,000, then surely they could also, as the same time, decide to draw down the full AVC in one go, and pay tax on it. Would this be allowed, and if so, what percentage tax would be applied ? Thanks in advance for your answer.
Regards,
T

 

[ClubMan]

In that case, isn't €200k tax free and the additional €50k taxed at 20%?

 

[Early Riser]

In that case, isn't €200k tax free and the additional €50k taxed at 20%?

Not in the case of a Defined Benefit Pension Scheme. The max is 150% of pensionable salary tax-free (120/80), as Conan indicated above. If @trident cashes in the AVC at retirement in the scenario he outlines, it will be subject to income tax (probably 40% in this case), USC and PRSI. Most people will transfer the money to an ARF rather than cashing-in the AVC.

Would this be allowed

The only scenario in which you can go beyond the 150% limit is if you are retiring beyond the normal retirement age for your scheme and you have more than the maximum number of years required for a full pension. So if your normal retirement age is 60 and you are retiring at 65 with 45 years service you could top-up your tax-free lump sum from an AVC by 15/80 - to bring it to 135/80. You cannot go beyond that. And you cannot go beyond 120/80 unless the service is both in excess of the maximum allowed in calculating the main scheme benefits, and it is served beyond normal retirement age for the scheme.

 

[trident]

Thanks Early Riser and Conan for the detailed replies. So the situation is this: I have an interest only mortgage, due around the time I retire. I need to have saved €300,000 by then to pay off the capital on the mortgage. I will have around €150,000 as a lump sum. I have an AVC, and assuming that I will pay about 50% tax on it when I cash it in upon retirement, I would need to have an AVC valued at around €300,000 upon retirement. Is this a reasonable plan?
Thanks in advance for any help/advice,
Regards
T

 

[Conan]

Thanks Early Riser and Conan for the detailed replies. So the situation is this: I have an interest only mortgage, due around the time I retire. I need to have saved €300,000 by then to pay off the capital on the mortgage. I will have around €150,000 as a lump sum. I have an AVC, and assuming that I will pay about 50% tax on it when I cash it in upon retirement, I would need to have an AVC valued at around €300,000 upon retirement. Is this a reasonable plan?
Thanks in advance for any help/advice,
Regards
T

That’s correct, BUT
- you will only get tax relief on AVC contributions at your marginal rate of Income Tax. - currently 40%
- the AVC fund will accumulate tax free within the fund
- but then under your plan (drawing down the full value as income in the year when you retire) you will possibly be taxed at c50% (PAYE +USC+PRSI).
So you need to consider your investment term to retirement. If you are only getting 40% relief on the way in but paying 50% on drawdown, it may not make much sense , unless you have a good number of years of tax-free growth.
If you only have a short period of years to retirement, then you might be better investing the AVC equivalent in a non-pension structrue.

 

[Buddyboy]

And on a slightly different, but related, note. You can use your AVC to boost your tax free lump sum, up to the 150% of pensionable salary. This could be the case if you don't have the full 40 years service.
So in the scenario above, if someone had a salary of €100k but only 20 years service, and therefore would only get €75k tax free lump sum, he could use the AVC to pay for the other €75k to bring the actual lump sum to €150k

 

[trident]

That’s correct, BUT
- you will only get tax relief on AVC contributions at your marginal rate of Income Tax. - currently 40%
- the AVC fund will accumulate tax free within the fund
- but then under your plan (drawing down the full value as income in the year when you retire) you will possibly be taxed at c50% (PAYE +USC+PRSI).
So you need to consider your investment term to retirement. If you are only getting 40% relief on the way in but paying 50% on drawdown, it may not make much sense , unless you have a good number of years of tax-free growth.
If you only have a short period of years to retirement, then you might be better investing the AVC equivalent in a non-pension structrue.

Thanks Conan. My plan is to contribut 20K per year for 10 years to an AVC. That, combined with another AVC would bring the total AVC to at least 300K.
Would you consider 10 years a suitable length of time to stick with the AVC approach of saving ?
Thans again in advance for any help.
Regards,
T

 

[Conan]

Thanks Conan. My plan is to contribut 20K per year for 10 years to an AVC. That, combined with another AVC would bring the total AVC to at least 300K.
Would you consider 10 years a suitable length of time to stick with the AVC approach of saving ?
Thans again in advance for any help.
Regards,
T

I think you firstly need to work out what your lump sum will be from your existing Pension Plan . Are a member of a DB or a D.C. Scheme? If you are not likely to get the Revenue max lump sum (say 150% of Salary from a DB scheme), then making AVCs to bridge that gap is clearly tax effective.
However going beyond that (as you suggest) is a questionable investment strategy. So if you are getting say 40% relief on the way in but paying say 50% tax on the way out, it would require a much higher gross return (within an AVC wrapper) over the 10 years to beat a lower net return (after tax on the non-pension growth).
In addition, if you allow for salary growth/inflation, you may get closer to the current €200k tax free limit over the next 10 years (it being questionable whether this cap will increase in future years).

 

[trident]

Thanks Conan for the explanation. All this has caused me to ask another question. Assume that a couple, both on public service pensions, have a combined pension which is at the limit of the 20% tax rate (I believe this is approx. 73K). Then if one of them had an AVC, and draws that down annually, that AVC income would be taxed at 40%, and I assume PRSI and USC, so while the AVC investment benefited from 40% tax relief on the way in, the AVC income would be taxed at about 50%.
So why would anyone/or any couple, who would have a relatively high annual pension brining them to the limit of the 20% tax rate, invest in an AVC in the first place?
Thanks in advance for any comments here.
Regards,
T

 

[Early Riser]

Then if one of them had an AVC, and draws that down annually, that AVC income would be taxed at 40%, and I assume PRSI and USC, so while the AVC investment benefited from 40% tax relief on the way in, the AVC income would be taxed at about 50%.
So why would anyone/or any couple, who would have a relatively high annual pension brining them to the limit of the 20% tax rate, invest in an AVC in the first place?

Good question.

One of the main reasons people invest in an AVC is because they are short of service for one reason or another, eg, working part-time, late joining the PS or planning to take early retirement. Once a person has a minimum of 20 years service they can use an AVC to top up the tax-free lump sum to 150% of pensionable salary. There is a sliding scale for fewer than 20 years.
For many people their retirement income may not take them into the 40% tax band. Again this may be for a variety of reasons - their pensionable salary in the first place, their duration of service, a spouse not having a pension, etc. So contributing to an AVC to get 40% tax relief makes good sense.

The first thing to do with an AVC is to top up the tax free allowance to the max - 150% if over 20 years. Then most people will convert it to an ARF, which can be drawn down on a yearly basis. Again most people will keep the draw down annually to an amount that keeps total income below the 40% tax rate - where possible. Just to note also that PRSI does not apply beyond age 66 - so it is just tax and USC at that stage.

Some people argue that it is still worthwhile to contribute to an AVC even if the drawdown in retirement is likely to incur 40% tax, USC (and, possibly, PRSI). This is because the growth within a pension fund is also tax free - it is not subject to capital gains, dividend income tax or DIRT. The theory is that the growth that this allows should still make it a worthwhile investment. A counter-argument is that against this tax-free growth there also has to be balanced the fees and charges associated with setting up and maintaining the AVC, and the charges in the subsequent ARF. Also, once money is put into the AVC it is tied up until retirement, whereas with other savings methods it should be more readily accessible, if circumstances require.

There have been several debates on this issue in these forums previously - without resolution, as far as I know. Personally, I would not want to invest into an AVC if it was likely to be taxed at 40% at drawdown - along with whatever else.

 

[OEP1990]

I have a question loosely related to this topic, I didn't want to start a new thread.

My wife is a teacher and I want her to start AVCs. Can an AVC be used for early retirement in the public sector or is it tied to the retirement age (66 or whatever it is)? If this is the case, are there other options available that can be used to fund early retirement in the public sector?

 

[Early Riser]

Can an AVC be used for early retirement in the public sector or is it tied to the retirement age (66 or whatever it is)?

No, the AVC is not linked to the State Pension age (if that is what you mean). It is linked to the Occupational Pension - in your wife's case the Public Service pension. So if she takes early retirement she has to "retire" the AVC at the same time - usually by converting it to an ARF to be drawn down as retirement income (after maximizing the tax free lump sum as far as Revenue allow).

 

[Benbulben]

Hi there, I have a question also closely linked to OP's original question and didn't want to start a new thread because the information on this one is excellent.

I would be in similar circumstances to OP. I am in a Semi State so maybe the rules of my pension differ slightly, maybe not. I will look into them though.

Like @trident I had thought that I could retire early at 60 (allowed by the scheme) with 40 years service. I have a circa €90k salary as an A Class contributor which would give me

Annuity : circa €31k
Lump Sum : circa €134 k

On my scheme A Class contributors deduct twice the old age pension to arrive at their reckonable pension wage. So in my case it would be €90k minus circa €28k which would give you €62 k x 40/80 = €31k.

You are not allowed to claim a supplementary pension if you retire before the State Pensionable Age. I am not sure if you could claim job seekers allowance but I do not believe so.

On calculating that DB pension pot using the relevant capitalisation factors of 20 (up to 31 Dec 2013) and 30 (current capitalisation factor for a 60 year old), the value of the pension pot would be circa €996 k.

I thought I could then deduct this from the Standard Fund Threshold SFT of €2m and have circa €1m to utilise.

I thought if I had an AVC of say €200k built up at 60 I could apportion €66k of it to the €134 lump sum I'd receive to top up the €200k tax free lump sum element and then liquidise the remaining €134k of the AVC immediately, paying 20% tax on it.

But I think from reading these posts that I cannot do any of that.

Am I correct in saying then that the SFT of €2m does not apply to DB schemes and you are actually limited to whatever the value of your DB scheme is ?

In my case my DB scheme would be circa €1m. Am I then precluded from making use of the first €200k lump sum tax free and the next €300k lump sum taxed at 20% ? In effect, precluded from making use of any of that additional €1m SFT threshold ?

 

[Early Riser]

Annuity : circa €31k
Lump Sum : circa €134 k

On my scheme A Class contributors deduct twice the old age pension to arrive at their reckonable pension wage. So in my case it would be €90k minus circa €28k which would give you €62 k x 40/80 = €31k.

That is the same as for a PS pension. In effect your annuity for full service combined with the State Pension should equate to 50% of pensionable remuneration.

You are not allowed to claim a supplementary pension if you retire before the State Pensionable Age. I am not sure if you could claim job seekers allowance but I do not believe so.

The PS Supplementary Pension is not a Social Welfare payment. It is paid by the employer in the event that the retiree is not working and not eligible for a Social Welfare payment. It is a subsidiary part of the Public Service pension scheme (class A PRSI). I have no idea whether any Semi-States operate a similar scheme.
You could claim Jobseeker's Benefit and it may or may not be approved. In any event, it is only for 9 months. You are probably not short of PRSI but if you are granted JB you also accumulate PRSI credits.

I thought if I had an AVC of say €200k built up at 60 I could apportion €66k of it to the €134 lump sum I'd receive to top up the €200k tax free lump sum element and then liquidise the remaining €134k of the AVC immediately, paying 20% tax on it.

This doesn't apply in Defined Benefit pension schemes. You are limited to 120/80 of pensionable remuneration tax free. But if you have any allowances or payments in your work which are not pensionable (eg, overtime) these can be used in addition to pensionable remuneration to increase Revenue's tax free limit.

Otherwise it would seem that you are limited to converting the AVC to an ARF and drawing it down at your discretion in retirement. With an annuity of €31K your probably can draw a fair bit annually without going into the top tax bracket. But that depends on your overall situation, other income, married, etc. Also, when you start drawing the State Pension the tax liability situation is likely to change.

 

[lawoman]

I see this being quoted a lot- if you have other allowances etc then you might be able to use these to increase that portion of your monthly pension in retirement that is tax free . But surely overtime would have already been part of your taxable remuneration so that wouldn’t count .
As for other income that would increase that portion of your pension that would be tax free ; when would you have to earn this for it to make any difference ? Would it be in the last three years before you retire or could you go back further than that .

The more I read about AVCs the more sceptical I get

 

[Early Riser]

But surely overtime would have already been part of your taxable remuneration so that wouldn’t count

AFAIK overtime is generally not pensionable in the PS (with some exceptions) but shift allowances are, eg,
"Pensionable remuneration means earnings that are reckonable for pension purposes, generally comprising salary and pensionable allowances (listed in the Department of Health Consolidated Salary Scales), but excluding overtime"
I don't know about Semi-States. But many grades in both sectors are not eligible for overtime anyway.

Would it be in the last three years before you retire or could you go back further than that

For pensionable allowances in the PS the 3 best years in the last 10 are considered. I don't know if Revenue operate on the same basis for non-pensionable payments.

The more I read about AVCs the more sceptical I get

AVCs in a defined benefit pension scheme make clear sense if you are going to be short of full service, as you can top up the tax free lump sum to 120/80 of pensionable emoluments provided you have at least 20 years of service (and on a sliding scale below this). I also think that funding towards an ARF makes good sense if you are likely to be able to draw from it at the 20% tax rate in retirement while getting 40% relief on contributions. They also should be considered by those looking towards early retirement. It is a much closer call in other situations. Some would argue that the longer term tax-free fund growth means they make sense even if drawdowns are at the higher tax rate - that wouldn't tempt me.

Different considerations apply to AVCs if it is not a defined benefit scheme.

 

[Benbulben]

Thanks very much for your replies @Early Riser .

Am I correct in saying then that there is no other way for me to benefit from the €2m SFT as I am on a DB ?

I'm effectively locked into the value of the DB pot and cannot avail of the 20% tax rate (no prsi, usc etc) on the first €300k after the €200k tax free limit on any other kind of lumpsum apart from the 120/80 that the DB gives you with full service ?

After reading the information that you and @Conan have kindly shared earlier in the thread I am starting to think that an AVC could still be good value in my particular case, just that I would need to re-assess how I would utilise it.

In my case, when I am hoping to retire at 60, my pension would be our sole source of income until we reach age 65.

My wife has a small deferred DB pension that may be worth circa €10k at age 65. Her Executive pension would also mature at that point (we could possibly draw down on that earlier, I will look into what potential penalties there might be)

Under the current OAP rules (we are both A Class and will both have full PRSI credits) we would then get circa €28k state pension at age 66 (who knows what the age will be at that stage) So from 66 onwards it should be fairly well funded. The reason to look to retire at 60 though would be to travel a bit and enjoy ourselves when we are hopefully fit and healthy.

If I had a 200k AVC that i converted into an ARF at age 60, I think I would be able to draw down the following each year before hitting the 40% band

Jointly assessed :

Pension : €31k
Tax credits : €3,550 ?
Employee PAYE Credit ? €1,775 (not sure if you can still claim this if you are using your pension)

Taxable income :


I think we would be able to earn €49k jointly before moving into the 40% I think this would allow us to draw down circa €23k from an ARF without putting us into the 40% tax band.

I think it's worth looking at creating some income stream for my wife from age 60 because we could then increase the €49k cut off point by the amount of income coming in to her (until it reaches €31k whichever is smaller)

 

[Early Riser]

Am I correct in saying then that there is no other way for me to benefit from the €2m SFT as I am on a DB ?

I'm effectively locked into the value of the DB pot and cannot avail of the 20% tax rate (no prsi, usc etc) on the first €300k after the €200k tax free limit on any other kind of lumpsum apart from the 120/80 that the DB gives you with full service ?

I am not a pensions professional, but I do not believe there is a way in your circumstances. The only way the €200k lump sum limit and the subsequent €300k at 20% would benefit in a similar DB situation is in the event of a very high salary - a person retiring on, say, €200k would have a retirement lump sum of €300k, the first €200k tax free and the other €100k at 20%.
Of course, if you had another pension from some other source, the overall €200k + €300k limit would apply, provided the rules of both schemes were individually adhered to.

Employee PAYE Credit ? €1,775 (not sure if you can still claim this if you are using your pension

Yes, you can.

I think we would be able to earn €49k jointly before moving into the 40% I think this would allow us to draw down circa €23k from an ARF without putting us into the 40% tax band.

Should that not be €18k from the ARF before hitting the 40% band? The same credits will apply to your tax deduction in any event.

My wife has a small deferred DB pension that may be worth circa €10k at age 65. Her Executive pension would also mature at that point (we could possibly draw down on that earlier, I will look into what potential penalties there might be)

Under the current OAP rules (we are both A Class and will both have full PRSI credits) we would then get circa €28k state pension at age 66 (who knows what the age will be at that stage) So from 66 onwards it should be fairly well funded. The reason to look to retire at 60 though would be to travel a bit and enjoy ourselves when we are hopefully fit and healthy.

It looks like you will have a good joint retirement income from 66. In that case I would be inclined to use the ARF in the preceding years to fulfil your travel, etc., dreams without being unduly concerned with hitting the 40% tax band. If you have (or are soon likely to have) a €200k AVC to transfer to an ARF then why not make use of that ARF? On the other hand, I personally would not be putting myself out in earlier years towards building an AVC this large if some of it is to be faced with 40% tax + 4% PRSI +USC. But that is only my opinion -others take a different view, given the potential for tax free fund growth over the years in the AVC.

By the way, did the broker who sold the AVC advise that you could use it to increase the lump sum beyond the 120/80 threshold?