Why should we pay Additional Voluntary Contributions (AVCs) if we are already paying into our pension?
The most compelling reason is to provide a higher level of retirement benefits. The larger the contribution, the larger the potential retirement fund.
In 2040 it is expected that only two people will be working for every one retiree, placing pressure on public expenditure budgets. For those of us in today’s workforce, we may need to face the possibility of a reduced State Pension or perhaps no State Pension at all.
When planning for your retirement, you will also need to consider what income you require between the age that you stop working and the age that you will receive any State Pension. The State Pension is currently payable (where applicable) at age 66, however this age is due to increase in the future. If you retire at age 65 will you have sufficient income from your pension arrangement to provide you with a reasonable standard of living until you become eligible to receive the State Pension? Paying AVCs now will give you an additional buffer should the age of retirement be increased.
For those of us focused solely on today and feel that retirement is a long way off, there is an immediate benefit of AVCs – tax relief. Paying AVCs will ensure you can avail of tax relief. This is something that will benefit you now and benefit you when you come to retire.
1. Tax relief on the way in: Tax Relief is given at your marginal tax rate of tax on AVCs paid (see the table).
There is no relief available in respect of PRSI and the Universal Social Charge and there is a maximum annual amount of earnings for which tax relief is given. Currently this is €115,000 p.a. This amount is adjusted from time to time by the Minister for Finance.
2. Tax advantage for the duration of your retirement saving: There is no tax deducted on any gains you make over the years you save for retirement – this compares well to other investment types where DIRT or CGT are applied.
3. Tax free amount when you draw down: Subject to Revenue limits, when you retire you can take a substantial amount of your fund tax free.
Whether you pay AVCs on a regular basis or as a lump sum really depends on your circumstances. If you are a PAYE employee and a member of an occupational pension scheme, or have a PRSA, that you contribute to by means of salary deduction via payroll, then you will receive your tax relief at source. Therefore a regular AVC payment would probably suit you best.
However, if you have other sources of income that necessitates a manual tax return each year then you may wish to pay an AVC prior to the end of each tax year to reduce your tax bill. You can make an AVC prior to 31 October (or later if you complete your tax return online – i.e. 10 December in 2020), each year and claim tax relief for the previous year. This will not only reduce your tax bill for the previous year but also your provisional tax bill for the current year.
A Simple Example in Action
Let’s imagine you have a tax bill of €10,000 to pay for 2019 and preliminary tax of €10,000 for 2020 by 31 October 2020. You could write a cheque to Revenue for €20,000 and your job is done.
But say you wish to take advantage of available tax relief. Rather than pay the full amount, you pay an AVC of €5,000 to your pension. This will have the effect of reducing last year’s tax bill by 40% of that €5,000 (i.e. €2,000). As preliminary tax is 100% of last year’s bill, you also reduce the preliminary tax by the same amount (i.e. €2,000).
Making a Choice
This leaves you with two clear options: Pay Revenue €20,000 or you can put €5,000 in your pension and pay Revenue €16,000 (i.e. €20,000 – €2,000 – €2,000). Your total spend is only €1,000 more, but for that extra €1,000 you pay Revenue the amount due and also have €5,000 in your pension fund – it’s a win win situation!
Making AVCs to your pension arrangement provides great benefits – today and for your retirement.
For further information please contact our experienced team at firstname.lastname@example.org
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