Over-Contribute to Pension; Compounding Benefit?

Cormac

Registered User
Messages
34
Hopefully someone can clear up something for me …

I am 41, so I can contribute 25% of my gross salary to a pension and get tax relief on it. This tax relief will be at my marginal rate, i.e. 40%. The general advice would be that maximising one’s tax relief allowances is very tax-efficient so I would like to do it. I will, if I remain on my present course, retire at 61.

At the moment, I am contributing

‘Dept. Of Education’ Pension 6%
Spouse and Child Pension 1.5%
Notional % Contribution, I am not sure of (For ease of use, let’s say 2.5%)

So, 6% + 1.5% + 2.5% = 10%.

Therefore, am I ‘wasting’ 15% of my tax-relief allowance by not utilising it? (Allowable Tax Relief 25% minus Claimed Tax Relief 10% = 15%)

My question is; can I over-contribute to my pension via AVCs, get tax-relief now, but pay tax on drawdown/in retirement?

I understand that my tax-free lump sum at retirement will be 1.5 x Final Salary. But, can I make that lump sum bigger and pay tax on the excess (anything above 1.5 x Final Salary)? For example,

Final Salary = €80,000; therefore, Tax Free Lump Sum = €120,000.

But could I use AVCs to increase that pot to, say €150,000, take the €120,000 tax free and pay tax on the excess €30,000? Or is this just simply not allowed by Revenue?

I’ve drawn up two scenarios below. Feel free to point out any errors that may be present.



Pension Investment


With tax relief, I pay €60 in and get €100 invested.

€100 compounded at 4% per annum for 20 years amounts to €219.

In 20 years time, when the time came to pay tax, I would pay tax on the €219.

Let’s assume I pay 52% tax on this (40% income + PRSI + USC); 52% of €219 = €114

(I think this would be correct; it would be seen as income, therefore taxed as such.)

So, I would be left with €219 - €114 = €105

So, my €60 has grown to €105.



Non-Pension Investment: Exit Tax Investment (I’ll assume, for purposes of illustration, that I’ll invest it in a fund that is subject to Exit Tax).

With no tax relief, I pay €60 in and get €60 invested.

€60 compounded at 4% per annum for 20 years amounts to €131.

In 20 years time, when the time came to pay tax, I would pay tax on the €131.

Let’s assume I pay 41% exit tax on this; 41% of €131 = €54

So, I would be left with €131 - €54 = €77

So, my €60 has grown to €77.


Any insights greatly appreciated!
 

Conan

Registered User
Messages
1,318
Firstly, you cannot “overfund” pension benefits. The Revenue set out how much pension assets you can accumulate with the benefit of the various pension tax breaks.
Essentially as a public servant your limit is:
- a Pension of 50% of salary (with a spouses pension on your death in retirement of 50%), plus
- a lump sum of 150% of salary
Currently, 40 years service is required to get this benefit. This benefit package is slightly less than the Revenue maximum allowable (your spouses pension could be 100% of your pension).
So depending on your years of service you may or may not have scope to invest AVC’s. You certainly CANNOT overfund Pension or lump sum benefits. So in your example, if your salary was €80,000, then the maximum lump sum is €120,000. You cannot invest AVC’s to build up a higher lump sum (even if the excess was taxable).
So I would suggest:
- consider what your service will be by normal retirement
- what benefit will that provide under the existing scheme rules
- calculate whether there will be any gap between what your Scheme provides and the Revenue maximum
- that will show whether there is any scope for AVC’s
If you are going to have full service (40 years) by normal retirement age, then your scope for AVC’s will be very limited. You might need to get professional advice from whoever manages your AVC scheme.
 

Cormac

Registered User
Messages
34
Thanks for that Conan.

Looking at your suggestions, I believe my situation would be as follows;

"- consider what your service will be by normal retirement"; with my purchase of Notional years, I will have full service at age 61.
"- what benefit will that provide under the existing scheme rules"; I believe this gives me a Lump Sum of 1.5 x Final Salary and a Pension of (approx.) 50% of final wage.
"- calculate whether there will be any gap between what your Scheme provides and the Revenue maximum"; This would put me at the Revenue maximum, I believe ..?
"- that will show whether there is any scope for AVC’s"; Does this basically mean I have no scope for AVCs?
 

Conan

Registered User
Messages
1,318
More or less YES.
You Could technically fund AVC’s to increase the Spouses Pension on your death in retirement to 100% of your pension rather than the 50% which your scheme provides (but probably not worth it). Also if you have any non- pensionable income you can fund pension benefits based on this. But since retirement is 20 years away, that will be difficult to assume.
So I suspect that AVC’s will not be a runner at this stage. But when you get closer to retirement you could look at the situation again.
 

Cormac

Registered User
Messages
34
Thanks again.

One point in particular you made may be of benefit to me;
"if you have any non- pensionable income you can fund pension benefits based on this."; I do, as it happens. At the risk of asking a lot, could I ask you direct me to where I might learn more on this (other threads on AAM, perhaps?).
 

Conan

Registered User
Messages
1,318
Depends on the type of non pensionable income. If it's related to your current employment then you might have scope for AVC’s
If it's a separate income then you may be able to establish a PRSA.
You need to get advice.
 
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Live Well

Registered User
Messages
50
Hi Cormac, Conan,

Hope you don't mind if I jump in with a question on Cormac's situation.

‘Dept. Of Education’ Pension 6%
Spouse and Child Pension 1.5%
Notional % Contribution, I am not sure of (For ease of use, let’s say 2.5%)

So, 6% + 1.5% + 2.5% = 10%.

Therefore, am I ‘wasting’ 15% of my tax-relief allowance by not utilising it? (Allowable Tax Relief 25% minus Claimed Tax Relief 10% = 15%)

Every post I read about financial independence in Ireland, talks about maximising your Pension contributions for Tax Relief

up to 30 years of age 15%
30 - 39 years of age 20%
40 - 49 years of age 25%
etc.

In Cormac's situation above, is he "wasting" the 15% of his potential tax relief or does the general advice on maximising pension contributions not apply to the Public \ Civil sector?
 

Conan

Registered User
Messages
1,318
You can only “maximize” your pension contribution if the overall result (combination of Main Scheme and AVC ) does not generate benefits in excess of Revenue limits.
For a Public Servant their main scheme will typically provide:
- Pension of 1/80th of Salary for each year of service (assuming he is a member of the old style DB scheme)
- a lump sum of 3/80ths of Salary for each year of service
- a Spouses Pension (on the member’s death in retirement) of 50% of the member pension
- indexation of benefits in payment.
So for example if you have 40 years service, then you are getting very close to the Revenue maximum and therefore little scope for AVC’s. If however you have short service, that’s where the scope for AVC’s exists.
However, it is not possible to “”overfund”. If you do, then technically the Main Scheme benefits must be reduced. Effectively, you should not be allowed to over-contribute. So before you contribute AVC’s you need to work out what the shortfall is between your Main Scheme and the Revenue maximum.
 

Early Riser

Registered User
Messages
1,110
For a Public Servant their main scheme will typically provide:
- Pension of 1/80th of Salary for each year of service (assuming he is a member of the old style DB scheme)

This is only applies to those on PRSI Class D/B. All post 1995 entrants will be paying Class A PRSI and will get an integrated pension (and pre -1995 in some public service sectors). These also have a defined benefit scheme but the Occupational Pension for them is not 1/80 of salary.
To keep it simple, for someone with full service at normal retirement age it is 40/80 minus the State Contributory Pension. So for someone with full service and a pensionable salary of €80,000, the Occupational Pension would ampount to approximately €27,000 (34% of pensionable salary).

Would a public servant on Class A PRSI with projected full service still not have considerable scope for AVCs?
 
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Conan

Registered User
Messages
1,318
Fair point, Early Riser. In that case there certainly will be scope for AVC’s. So even with 40 years service, it would be possible to fund for the difference between the integrated pension (40/80 x Salary - State Pension , c€27k in your example) and the max of 50% of salary (since the 150% lump sum is in addition).
 

JudeMcA

Registered User
Messages
5
Cormac,

Just read your first post and I'm not sure if you got your sums right. In the Non Pension Investment you assumed 41% tax on the full amount not the return.

You would pay 41% on (€131 - €60) = €29 leaving you with €102.

If I'm correct then you only gain €3- over 20 years by tying your money in a pension and would lose the freedom of getting this earlier if you wanted it and you would not be subject to any of the rules above.

I know the actual situation is more complex and that you have to pay your tax on the fund every 9 years and that in general savings seem to incur more management fees than AVCs.

Am I right?

Jude
 

Cormac

Registered User
Messages
34
Cormac,

Just read your first post and I'm not sure if you got your sums right. In the Non Pension Investment you assumed 41% tax on the full amount not the return.

You would pay 41% on (€131 - €60) = €29 leaving you with €102.

If I'm correct then you only gain €3- over 20 years by tying your money in a pension and would lose the freedom of getting this earlier if you wanted it and you would not be subject to any of the rules above.

I know the actual situation is more complex and that you have to pay your tax on the fund every 9 years and that in general savings seem to incur more management fees than AVCs.

Am I right?

Jude
Jude,

I think you're correct. Well spotted. Mea culpa.
Thanks for pointing it out.

Cormac
 

Moribund

Registered User
Messages
24
You can only “maximize” your pension contribution if the overall result (combination of Main Scheme and AVC ) does not generate benefits in excess of Revenue limits.
For a Public Servant their main scheme will typically provide:
- Pension of 1/80th of Salary for each year of service (assuming he is a member of the old style DB scheme)
- a lump sum of 3/80ths of Salary for each year of service
- a Spouses Pension (on the member’s death in retirement) of 50% of the member pension
- indexation of benefits in payment.
So for example if you have 40 years service, then you are getting very close to the Revenue maximum and therefore little scope for AVC’s. If however you have short service, that’s where the scope for AVC’s exists.
However, it is not possible to “”overfund”. If you do, then technically the Main Scheme benefits must be reduced. Effectively, you should not be allowed to over-contribute. So before you contribute AVC’s you need to work out what the shortfall is between your Main Scheme and the Revenue maximum.
How do revenue calculate if you are overfunded?
How do they translate the remaining value of your AVC (after maximising the lump sum) into an annual amount? Do they take annuity rates for the age of the retiree?
If they do decide that you are overfunded how do they reduce the Main scheme benefits?
e.g. consider the scenario below where someone retires shortly before official retirement date with reduced lump sum and pension
Salary €60k ==> Max Lump Sum €90k, Max pension €30k per year
Actual reduced Lump sum : 80k (10k short of max allowed)
Reduced pension at for example 58: 27k (3k short of max per year)
Assume AVC of €310k ==> €10k goes to maximise lump sum leaving 300k to fund for 3k per year from age 58.... would they take annuity rates
 
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