The generous but much neglected AVC can give your retirement pot a massive boost, writes Eithne Dunne
They are, by some way, among the best tax breaks still available. Additional voluntary contributions (AVCs) are extra, tax-free pension payments designed to build up your retirement pot. As with main pension payments, you can get tax relief on these contributions at the marginal tax rate, making them the last of a rapidly dying breed of hefty tax breaks, according to Killian Nolan, head of business development at Independent Trustee Company.“Years ago there were lots of [tax breaks], for example you could buy seaside properties and get the tax back, but the government has eliminated them all,” he said. “This is the last, and by far the most generous, yet it’s completely under-used.”
Nolan added the AVC is even better than former finance minister Charlie McCreevy’s special savings incentive accounts, where the state paid 25% top-up on savings. “The government will give you 40% if you are taxed at the higher rate. So if you put in €100 it will only cost you €60, and you won’t be taxed on any gains.The only catch is you can’t access the funds until retirement.”
Eamon Dwyer, managing director of City Life Wealth Advisors, said relatively few people in corporate pension schemes avail of AVCs. “They start to do so when they get a bit older and realise they don’t have enough in their pension fund, but very few start from a young age. AVCs are a fantastic idea. With everything else you will pay capital gains tax or Dirt. There’s nothing to be afraid of with AVCs; you can look at it as a long-term savings account.”
Who should consider AVCs?
AVCs are a good idea at any age if you have a few quid to spare at the end of every month and a reasonable rainy-day fund. “There are a lot of people in their late twenties and early thirties earning reasonable money and, because it’s so hard to buy or rent, they’re living at home,” said Dwyer. “Many have plenty of disposable income. My advice is that if they have a few hundred in their account at the end of the month that they’re currently putting into short-term savings, put half that into AVCs.”
For PAYE workers it’s a simple process. “If you do it through payroll, it comes out and is there on your pay slip,” said Nolan. “At the end of the year you don’t need to do a return, it’s all done at source.”
Jerry Moriarty, chief executive of the Irish Association of Pension Funds, said many defined contribution schemes now offer matched contributions where the employer will pay more if you also do. “Obviously this should be the first thing to do if you are considering paying more.”
If you are self-employed or have your own private personal retirement savings account (PRSA), you can make your extra contribution to your fund and claim the tax relief on your annual return.
There are limits on the scale of contributions attracting relief, capped as a percentage of earnings (see table). For PAYE workers, this means your gross salary; for the self-employed it means your income less allowable expenses. The maximum allowable income for these calculations is €115,000 per year.
Note also that there is a €2m tax-free threshold; if you end up with more than this in your pot at retirement, you’ll pay tax on the excess contributions. “We see this reasonably often with people who have that level of pension funding,” said Paddy Delaney, creator of the Informed Decisions financial planning podcast.
Advantages of AVCs
AVCs also give more options at retirement, said Delaney.
“You can increase your tax-free lump sum, increase the income you get via an annuity, or increase the slice of the pie you get in an approved retirement fund.”
There’s nothing to be afraid of with AVCs; you can look at it as a long-term savings account
Dwyer said that if you’re in a defined benefit pension scheme and have built up a good AVC fund, you should be able to take a tax-free lump sum on retirement without reducing your guaranteed income from your pension scheme. In most other cases, you will still typically get 25% of your total fund (pension plus AVCs) as a tax-free sum on retirement, and the bigger your AVCs, the bigger this will be. AVCs are the same for private or public sector workers. However, if you are a public sector employee and have a defined benefit pension, you may decide you want to buy additional years of service through what’s called notional service purchase rather than opting for AVCs.
Delaney urges consumers to ask about fees up front.
Typically, though not always, an AVC fund available through an employer will have a lower annual management charge than a stand-alone fund. As with any form of investment, a seemingly small difference in fees can have a big impact in the long term. “If you invest €10,000 for 25 years, a 1% fee will erode about 30% of the growth, whereas a 1.5% fee will erode more than 40% of that growth,” said Delaney.
If you have your own PRSA/AVC fund, you will pay an annual management fee. For standard PRSAs this is typically 1% of the fund value. Then you will usually also be charged a contribution fee, which for a standard PRSA can be up to 5% of each contribution. It is possible to set up an execution-only fund, which will only involve an annual management fee (meaning 100% of your contributions will be invested), but you will not be entitled to any advice.
Where your contributions go
If you have a defined benefit pension, your extra contributions will usually go into a separate AVC fund; if you have a defined contribution scheme, it will go into the same fund as your main pension. If you are self-employed or there is no pension scheme in your workplace, you can make additional payments to your existing PRSA fund.
You should have at least some say over how you want your AVCs invested. “If you have a long time to go to retirement, the best advice is to go for a reasonable level of volatility for the best return; if you have only a few years to go, choose a low level of volatility,” said Delaney.
Moriarty said that, while it’s important to be conscious of the amount of risk you can afford to take as you approach retirement, it is also possible to transfer your AVCs to an approved retirement fund and continue to invest after retirement.
“That could give you a reasonably long investment horizon,” he said.
“There are lots of different possibilities and rules when it comes to paying AVCs and having benefits paid,” said Moriarty. “This can be further complicated as more people have bits of defined benefit pensions, defined contribution pensions and AVCs. It makes sense to engage an independent financial adviser to ensure you get the best outcome.”
Under 30 15% of earnings Age 30-39 20% of earnings Age 40- 49 25% of earnings Aged 50-54 30% of earnings Aged 55- 59 35% of earnings Aged 60 40% of earnings