Understanding Scope for AVCs in Integrated Defined Benefit Pension

[Ent319]

Hi everyone. I've been doing some research on pensions and AVCs. I've managed to confuse myself multiple times at this stage but I think I've finally figured things out. I've read my pension scheme booklet (https://singlepensionscheme.gov.ie/wp-content/uploads/2017/12/Scheme-Booklet.pdf), the revenue pensions manual and numerous posts from Askaboutmoney over the years. I'm posting this in the general pension forum rather than the public sector pension forum because (if I understand things correctly) the implications will be the same for defined benefit pension schemes irrespective of whether they're public or private.

I've condensed my research into the bullet points below. Can anyone tell me if I've gotten anything wrong / am missing anything important?

• Additional Voluntary Contributions (AVCs) exist as a mechanism to supplement the benefits received under an existing occupational pension scheme where these are less than the maximum pension benefits allowed under Revenue rules. AVCs cannot be made unless someone is a member of an existing occupational pension scheme.
• Revenue's rules around the maximum benefits that can be received under an occupational pension scheme are contained in their pensions manual, which distils many of the rules from the Taxes Consolidation Act.
• The general rule for occupational pension schemes is that they cannot exceed 2/3 final salary. There are multiple variations as to how 2/3 salary can be reached depending on the kind of pension e.g. defined contribution or defined benefit.
• The maximum benefits that someone can receive under their pension will be reduced if they retire early.
• If a defined benefit occupational pension scheme has a 1.5x Final Salary Tax Free Lump sum, the maximum pensionable remuneration allowable under revenue rules for that scheme (according to actuarial calculations) will be 40/80s of final salary, or half of final salary. What constitutes "Final Salary" is again determined through actuarial calculations.
• An Integrated defined benefit pension is one which has regard to the current levels of State Pension in calculating the benefits gained under the scheme. The current pension scheme for new entrant public servants - the Single Public Service Pension Scheme - is an integrated scheme.
• While an integrated defined benefit pension scheme might have regard to the State Pension in assessing what benefits are made available under the scheme, the State Pension itself is not relevant for calculating whether the maximum benefits under revenue rules have been reached. In other words: in assessing scope for AVCs in such a scenario, the State Pension should be ignored and if the scheme pays less than 50% final salary, an AVC pot can be used to make up the deficit.
• Income Tax relief is granted on pension contributions at the individual's marginal rate (e.g. 20% or 40%). Relief is not granted on USC and PRSI.
• The amount that can be contributed to an AVC in any given year is capped by revenue as a percentage of salary in various age brackets.
• If you're paying 40% income tax now and expect to be below the 40% income tax threshold in retirement, pension contributions are an absolute no brainer as this is "true" tax relief. Even where total pensionable remuneration in retirement is expected to exceed the 40% income tax threshold, and is likely to be hit by USC again on the way out, making pension contributions up to revenue limits is likely to be a financially advantageous way to invest because a pension:
  • is the only readily accessible way to invest in collective investment vehicles for equities in Ireland without suffering the approx 30% long term hit to growth from the deemed disposal rule without having to deal with accountants and form 11s for the rest of your life;
  • gains compounding benefits not available in any other investment product from the "loan" of income tax from revenue - as outlined in Marc's post on the first page of one of the key posts in this forum.
• It's extremely important not to over-invest in AVCs by exceeding revenue rules for pension benefits in the short term (by over-contributing each year) or in the long term (by over saving). The benefits gained under your occupational scheme will be reduced to compensate in the event you over-fund your AVC pot, and revenue might claw back tax relief on any excessive contributions.

 

[Conan]

Well done. You certainly have “figured things out”.
My only comment would be that many people who contribute AVCs tend to be somewhat older (say 50+) and typically older investors tend to be risk averse and less likely to invest in Equities. So in the current climate this means that investment growth is not guaranteed. Indeed positive growth is challenging. It is certainly a “no brainier” to invest AVCs to maximise the tax-free lump sum, but not such a clear case in terms of funding extra pension income if the tax rate (PAYE+USC) is going to be higher (on the additional pension) than the tax relief on the contributions.

 

[Ent319]

Well done. You certainly have “figured things out”.

Thank you - it's been a journey. I was financially illiterate before lockdown this year and have been learning about investing, index funds, pensions etc ..... over the past six months. These forums have really been invaluable for understanding the Irish situation, and I've definitely read more than one of your posts here!

My only comment would be that many people who contribute AVCs tend to be somewhat older (say 50+) and typically older investors tend to be risk averse and less likely to invest in Equities. So in the current climate this means that investment growth is not guaranteed. Indeed positive growth is challenging. It is certainly a “no brainier” to invest AVCs to maximise the tax-free lump sum, but not such a clear case in terms of funding extra pension income if the tax rate (PAYE+USC) is going to be higher (on the additional pension) than the tax relief on the contributions.

It's the conclusion I came to when I looked at the other equity investment options in Ireland. Even with that additional USC hit, it seems to be the only way of investing in ETFs in Ireland without accountancy fees and sluggish growth due to deemed disposal (hello degiro) or currency issues + dealing with active fund managers (hello investment trusts). Standard Life's Vanguard Global stock index fund with a 0.9% AMC seems to be one of few decent after-tax equity investment products available in the Irish market but again, deemed disposal makes it a little bit sus compared to paying off your mortgage early.

 

[LDFerguson]

Fantastic post. Thank you for sharing it here. I'd suggest that this should be a key post for easy reference.

I'd have a few comments.

• Tax relief on an AVC is, as you say, capped as a percentage of salary depending on your age. This cap includes any ordinary contribution you are already making to the pension scheme. For the purpose of this calculation, salary is capped at €115,000.
• I see that you've posted this in the general pensions forum as the general principles apply to both public sector and private sector pension schemes. However, it would probably be worth noting that in some public sector schemes, the option exists to buy additional years' service in the scheme as an alternative to making AVCs. If that facility exists, I believe it should always be evaluated as an option in the context of your particular circumstances, even if you eventually decide to start an AVC anyway. There are several threads here on Askaboutmoney comparing AVCs with buying back years.
• Most if not all pension schemes have the facility to make AVCs. Public service schemes will usually have an AVC scheme arranged through the relevant trade union. You also have the option of starting an AVC PRSA with the provider of your choice. The incumbent AVC schemes should be compared with an AVC PRSA before choosing, in terms of charges, investment choices, convenience etc. Again the correct one for you will depend on your specific circumstances and requirements.

Regards,

Liam
www.ferga.com

 

[Early Riser]

Well done @Ent309.

Just a couple of points around the edges.

If a defined benefit occupational pension scheme has a 1.5x Final Salary Tax Free Lump sum, the maximum pensionable remuneration allowable under revenue rules for that scheme (according to actuarial calculations) will be 40/80s of final salary, or half of final salary.

I am not sure if this is entirely accurate or, perhaps, I am misunderstanding your point. I take it you are saying that the maximum pension benefits Revenue will allow, even with AVCs, is 120/80 of final salary as a lump sum and 40/80 of final salary as annual pension ? If so, I would refer you to Chapter 5 of Revenue's Pension Manual : https://www.revenue.ie/en/tax-professionals/tdm/pensions/chapter-05.pdf.
Your reference earlier in your post (second bullet point) to actuarial calculations for the Revenue limit covers this better.

As another side issue, there are some situations in which the 120/80 tax free lump sum limit may be breached. When a public servant has more than 40 years service and retires after normal retirement age a lump sum of up to 135/40 may be allowed (ie, for up to 45 years service). As far as I know, there are also some adjustments to the maximum allowable annual pension. Any such benefits would have to be funded by AVCs - they do not come with the main scheme. This pertains at least to pre-1995 entrants who pay the lower adjusted PRSI rate. I am not sure if it also applies to post 1995 entrants, or indeed to non-public service schemes, but I assume that it does.

An Integrated defined benefit pension is one which has regard to the current levels of State Pension in calculating the benefits gained under the scheme. The current pension scheme for new entrant public servants - the Single Public Service Pension Scheme - is an integrated scheme.

While the Single Scheme is, indeed, an integrated pension scheme, it is not a final salary scheme. I do not know how Revenue calculates the maximum limit it will allow for the lump sum in such circumstances. For example, someone retiring after normal retirement and with 20 years service in a final salary scheme could top up the lump sum to 120/80 of final salary. What the calculation is for the Single Scheme I do not know.

The maximum benefits that someone can receive under their pension will be reduced if they retire early.

This is entirely accurate but it may be worth adding that the maximum benefits Revenue will allow are still in general considerably more than the scheme will provide, and AVCs can be or particular advantage in such circumstances, Also, for people on integrated schemes who retire early, they will have to wait until State Pension age to claim this "portion" of pension income. An AVC can be useful to fund this gap.

 

[Ent319]

Thanks for the kind words. It's reassuring to hear I'm on the right track from people that know what they're talking about - even if I'm not getting all the particulars right. I've addressed some of the comments made below where I feel I could provide added value.

I see that you've posted this in the general pensions forum as the general principles apply to both public sector and private sector pension schemes. However, it would probably be worth noting that in some public sector schemes, the option exists to buy additional years' service in the scheme as an alternative to making AVCs. If that facility exists, I believe it should always be evaluated as an option in the context of your particular circumstances, even if you eventually decide to start an AVC anyway. There are several threads here on Askaboutmoney comparing AVCs with buying back years.

This is, I think, only an option available to public servants Pre-Single Scheme (i.e. pre-2013).

Under the single scheme there is now a facility to buy benefits. A calculator for the benefits that can be purchased is available here and the terms upon which benefits can be purchased is available in the DPER Circular here.

While benefits purchased are equivalent to benefits received normally under the scheme (e.g. they are index linked, State Guaranteed), I have to say that from experimenting with the calculator a little bit they don't seem to be particularly good value vs. private options. For someone who's thirty years old at the moment, €1 of referable pension will cost you €23.44, and €1 of lump sum will cost you €0.92 (not factoring in any tax relief or end tax for pension received).

While I haven't done the maths, that seems like a pretty bad deal for anyone in a position to use as an AVC as an investment vehicle for long-term growth, and then to eventually have the money sitting in an ARF earning compound interest on the "loan" of income tax from revenue.

Most if not all pension schemes have the facility to make AVCs. Public service schemes will usually have an AVC scheme arranged through the relevant trade union. You also have the option of starting an AVC PRSA with the provider of your choice. The incumbent AVC schemes should be compared with an AVC PRSA before choosing, in terms of charges, investment choices, convenience etc. Again the correct one for you will depend on your specific circumstances and requirements.

Would I be correct in saying that, all other things being equal, in the long-term, at source deduction might be more beneficial for long-term investment? By instantaneously getting the benefit of tax relief, your cash flow is better and the money you otherwise would have spent paying tax (to be rebated) can be invested through other means (e.g. to reduce debt, or in after tax investment). Over the course of 35/40 years I would imagine this would add up.

I'm not quite sure how the revenue rebate for tax relief works if you start a separate non-source deducted AVC PRSA. Does this get dumped in your bank account by revenue in a lump sum after you file your return?

The at source deduction option provided to me through my union - Forsa - is through Cornmarket. Terms of Business here. AMC is 1% on first €40,000, 0.75% on next €100,000, then 0.5% thereafter. Seems pretty decent considering most AMCs in Ireland hover around 1% flat. I don't know whether this fee structure is available only on Cornmarket's Public sector funds (Cautious, Balanced, Adventurous), or whether it's also available for all Irish Life funds and the other funds you can invest in (Zurich, Aviva, Friends First). I might email them and ask. If it was it would mean you could access Zurich's index equity funds at favourable rates .....

I am not sure if this is entirely accurate or, perhaps, I am misunderstanding your point. I take it you are saying that the maximum pension benefits Revenue will allow, even with AVCs, is 120/80 of final salary as a lump sum and 40/80 of final salary as annual pension ? If so, I would refer you to Chapter 5 of Revenue's Pension Manual : https://www.revenue.ie/en/tax-professionals/tdm/pensions/chapter-05.pdf.
Your reference earlier in your post (second bullet point) to actuarial calculations for the Revenue limit covers this better.

This is what I was trying to say - you said it more more elegantly!

As another side issue, there are some situations in which the 120/80 tax free lump sum limit may be breached. When a public servant has more than 40 years service and retires after normal retirement age a lump sum of up to 135/40 may be allowed (ie, for up to 45 years service). As far as I know, there are also some adjustments to the maximum allowable annual pension. Any such benefits would have to be funded by AVCs - they do not come with the main scheme. This pertains at least to pre-1995 entrants who pay the lower adjusted PRSI rate. I am not sure if it also applies to post 1995 entrants, or indeed to non-public service schemes, but I assume that it does.

Very interesting. Noted.

While the Single Scheme is, indeed, an integrated pension scheme, it is not a final salary scheme. I do not know how Revenue calculates the maximum limit it will allow for the lump sum in such circumstances. For example, someone retiring after normal retirement and with 20 years service in a final salary scheme could top up the lump sum to 120/80 of final salary. What the calculation is for the Single Scheme I do not know.

Edit and fixed: Misunderstood what you were saying here.

Benefits gained under the Single Scheme are complicated to work out. If you were on the Single Scheme and your pay remained consistent for forty years and the State Pension remained consistent, you'd be able to work out exactly how much you'd be able to get (like a final salary scheme). In reality, going up (or down) salary over the course of your career makes the calculations insanely complicated as entitlements are gained as a "snapshot" of your salary at each point in time over the course of your career. It follows that a Single Scheme Member's scope for AVCs increases the more jumps (upwards) in salary over the course the course of their career.

One final thing that I want to look into is how to work out when to stop investing in AVCs to avoid an overfund. I think this is Page 4 onwards of Chapter 5 of the revenue's pension's manual. I've bounced off it a few times now because it's in actuary-speak and, for the reasons discussed previously, as a single scheme member, it's very difficult to work what my benefits will actually be.

 

[Early Riser]

From what I have gathered, the Single Scheme does seem to be treated as a defined benefit scheme

I agree it is treated as a defined benefit scheme but it is not a final salary scheme. I am not sure how the Revenue maximum tax free allowance is calculated for the Single Scheme. In a final salary scheme the maximum is 120/80 of final (pensionable salary). A public servant member of such scheme who retires at normal retirement age and with 20 years service would get 60/80 of final salary from the main scheme. They could top this up with another 60/80 tax-free from an AVC. But what is the Revenue max if this public servant happened to be in the Single Scheme ?

 

[Itchy]

Are the limits not the same I.e. 120/80 of final salary. So for a Single Scheme member it may take 25 years for the benefits to reach 60/80 and they have scope to top up by 60/80.

 

[Conan]

Revenue limits don’t change based on the type of scheme you are in. The max lump sum is 150% of Final Salary (a few definitions of same) subject to having at least 20 years service. So if your scheme (whether Final Salary DB or revalued average salary) pays out less than 150% (and you have at least 20 years service) then using AVCs to maximise your lump sum is a “no brainier”.
The difficulty with the the single scheme is that it is more difficult to estimate the possible shortfall in advance (it’s not simply the number of years short of 40).

 

[Early Riser]

So for a Single Scheme member it may take 25 years for the benefits to reach 60/80 and they have scope to top up by 60/80.

I am not sure where the 25 Years comes from? Anyway, the Single Scheme works by "accruing" a percentage of annual salary towards the lump sum. There does not seem to be any way to work out in advance what percentage of final salary a set number of years in the Scheme (eg, 20 or 25) will provide by way of lump sum from the Scheme pension.

 

[Ent319]

From what I can see, the only certainty you have about your final pension benefits as a single scheme member in terms of scoping AVCs is that:

1. Because the Single Scheme is an integrated scheme there will always be scope for AVCs to make up an amount of pension equivalent to the State Pension. [I wonder does this hold true at all salary levels?]
2. Because your salary will (hopefully) rise as a public servant over the course of your career from increments, ad hoc pay bumps and promotions, this will cause a gap between the pension you accrue in practice and maximum benefits allowable under revenue rules over the course of your career.

Obviously this assumes there are no major salary drops or life choices which affect your final salary (e.g. going part time).

To me, it would seem sensible to go low and slow with AVCs as a Single Scheme Member e.g. drop in €60-€70 net a fortnight for a couple of decades and avail of compound interest as best you can while avoiding risk of overfunding. You never really know the exact amount you're going to need but you know you'll need something.

I do need to have a closer look at the purchasing facility calculator though. Maybe buying €1 of inflation protected referable pension for €23.44 (€14 net after tax relief) in current euros isn't actually that bad a deal? Edit for Posterity: Looked into this in another thread here.

 

[Itchy]

I am not sure where the 25 Years comes from? Anyway, the Single Scheme works by "accruing" a percentage of annual salary towards the lump sum. There does not seem to be any way to work out in advance what percentage of final salary a set number of years in the Scheme (eg, 20 or 25) will provide by way of lump sum from the Scheme pension.

The 25 was just arbitrary. Picked just to reflect the poorer terms.

It's certainly more difficult to calculate.

 

[Ent319]

Just a small update to this thread. Under Chapter 5 of the Pensions Manual, it appears that the max amount of money that can be invested in an AVC on retirement by someone who's a member of an integrated defined benefit scheme to account for the "gap" in max allowable revenue pension benefits from the current State Pension (€12700), and who's normal retirement age in their scheme is 68, is roughly (not accounting for any future variations in state pension, changes in tax / pension policy or changes to future limits due to inflation):

- male, unmarried: approx €230,000.
- female, unmarried: approx €275,000
- male, married: approx €330,000
- female, married: approx €300,000

This is obviously subject to annual contribution limits discussed previously as well.

I was going to ask the thread why the capitalisation factors in the first table of Chapter 5 of the Pensions manual reduce with normal retirement age but then I realised that it's because you're likely to pop your clogs earlier into retirement and not need as much pension. Lovely!

Why do married couples get much larger benefit limits?

 

[Conan]

The the capitalisation factors reduce the later the assumed retirement. So the “capital value” of a pension at say 65 is less than the equivalent value assuming a retirement age of say 60.
The example quoted in Chapter 5 assumes full scheme service (typically 40 years). AVCs can be used to bridge a number of potential gaps:
- short service
- if the main scheme does not index the pension in payment
- if the main scheme does not provide a spouses pension on the members death in retirement
But even in the example shown (a Civil Service type scheme), there can be gaps even if the member has full service:
- using a better definition of Final Salary (eg including non-pensionable allowances), which can give a higher pension and lump sum
- whilst the scheme does provide a Spouses Pension, it’s only 50% of the Member Pension. But the Revenue limit is 100% of the Member Pension
So even a full service civil servant will have some limited scope for AVCs.

And the reason couples get a higher capitalisation factor is to allow for a Spouses Pension.

 

[HynesMA]

I am with Irish Life, I am in a defined benefit scheme for about 30 years, I am paying maximum amount AVCs now as I have 5 years left .
I am disappointed with Irish Life charges ….. for example a 59 Euro charge to lodge 5000 euro lump sum !!! ….
It costs Variable about Euro 1.81 to lodge Euro 150 weekly …… !!!! …
Would I be correct in saying Irish Life is more charging more than other companies in the irish marketplace and performing lower when compared ??????? !!!!!!!!!

 

[LDFerguson]

Would I be correct in saying Irish Life is more charging more than other companies in the irish marketplace and performing lower when compared ??????? !!!!!!!!!

No. Irish Life, like all of the pension companies offer a wide range of charging options on any of their pension products. They introduce new options regularly. The person who is selling you the product chooses one of the available options of the time. The seller might be a broker, a tied agent, or a bank employee. Some of the options involve high charges and high commissions for the seller; some of the options involve lower charges and lower commission for the seller. If you are not happy with the charges on your AVC it is because the person that sold it to you chose that particular charging structure, out of the range available. You should go back to the person who sold it to you and express your dissatisfaction and bring examples of better charging structures to back up your complaint.