# AVC for non earner



## igloo (1 Oct 2012)

Probably an obvious answer to this one.. 

my wife has inherited some money and was thinking of topping up her pension fund with some of the proceeds (€20k).  She has not worked for four years though, and as a result has not paid any tax or completed any self-assessment tax returns.

The question is, can she make an AVC toward her pension fund in 2012 (held in trust by administrators of her previous employer), and in turn claim tax-back on it?  I realize that AVC contributions are governed by bands based on age range e.g. 40-49 year old may contribute 25% of net earnings etc.  But.. what if you have no earnings per se?

Thanks for any advice here.


----------



## LDFerguson (1 Oct 2012)

No, she can't make an AVC to a pension scheme if she's no longer with that employer.  

If you're in employment, can she make a contribution towards your pension instead?  (What's mine is mine and what's yours is ours. )


----------



## Marc (1 Oct 2012)

I have looked at this question in some detail and the PRSA legislation is drafted in such a way to permit everyone to contribute to a PRSA irrespective of their earned income.

If you do not have earned income in the current year, contributions can be carried forward (seemingly without limit) until you have earned income to set against.

This legislation seems to be loosely based on the UK Stakeholder pension rules.

In the UK pensions can even be established for minors by the parent or guardian signing the application on behalf of the child. This is extremely tax efficient if contributions are paid by a grandparent as there is an inheritance tax saving into the bargin.

Equally, many people who are retired also contribute to pensions in the UK.

However, the difference in the UK is that everyone is entitled to basic rate tax relief at source.

So the position in Ireland for someone thinking about paying into a PRSA would appear to suit anyone who is not currently working but who expects to have earned income in the future so that they can offset contributions against future income tax, but who probably doesn't expect to be a member of an occupational pension scheme.

Example:
Consider the situation where a Grandparent has a sizeable estate that they wish to pass onto their two children but they are aware that the total value will be in excess of the total allowances available for their children (i.e. their estate is worth more than €500,000).

Let’s assume that the Grandparents have a grandchild aged 18 who is at University who has little or no income of their own.

Many Grandparents might be unhappy to make substantial outright gifts directly to their grandchildren, but many would be willing to invest in their future.

Under Irish CAT laws, the first €3,000 of the total value of all gifts received from one person in any calendar year is exempt. This means that the Grandparent or indeed the parent may give a gift of up to €3000 each and every year to their Grandchildren and this gift is immediately exempt from Capital Acquisitions Tax. This transfer results in an immediate tax saving of €900 each year under the current tax rate of 30%.
Rather than make the gift directly to their grandchildren, the grandparent could set up a Direct Debit to pay a premium of €3000pa to a Personal Retirement Savings Account in the name of the Grandchild.

Except in the case of an employee who is a member of an occupational pension scheme or of a statutory pension scheme, a taxpayer is entitled to tax relief on a contribution of €1,525 paid even if this exceeds the normal income-based limit.
Revenue provide an example as follows: If an individual aged 23 earns €9,525, the normal limit on the tax deductible contribution is 15% of €9,525, which equals €1,430.
If this individual pays €1,600, relief of €1,525 will be allowed, rather than the earnings based limit of
€1,430 .

Contributions paid in any year in excess of the maximum tax deductible contribution may be carried forward and claimed in future years subject to the annual limit for those years. Similarly, contributions paid while out of the workforce may be carried forward and claimed against future earnings on return to paid employment subject to the annual limits.

The tax relief is non-transferable between spouses in line with existing rules for retirement annuity contracts (RACs) and occupational pension scheme contributions.

A contribution not allowed in one year because it exceeds the age or income related limit may be carried forward and relief allowed in subsequent years. If a contribution is paid after the end of the year, but before the following 31 October, relief may be allowed in the earlier year provided an election to do so is made by the individual on or before the 31 October. Taxpayers filing returns under ROS may avail of the extended filing date to make an election and pay a contribution.
The practical upshot of these rules is that where the Grandchild is not earning significant income the unused income tax credits can be carried forward until such time as they have sufficient income to offset against the tax credits.
The benefit to the child or grandchild from the income tax relief depends on the ultimate rate of tax paid by the child but assuming they only obtain lower rate tax relief of 20% then based on the allowance of €1525, this equates to income tax relief of €305.

Therefore the cumulative effect of these two tax reliefs equates to €1205 against €3000 paid or a total of 40.1% in tax reliefs.
The grandchild cannot access the funds in the pension until they are at least 60 years of age satisfying the desire on the part of many grandparents to invest in their grandchild's future.
All profits and income generated within the pension fund are free of personal taxes (income tax and capital gains) and the fund is not subject to exit tax. Broadly speaking, this means that the investment gains are between 30% and 33% more tax efficient than alternative investment options and income earned is up to 41% more tax efficient.

Assuming an average investment return of 6.5%pa these tax savings might be expected to add around 2%pa compared to alternative forms of investment from which we currently need to deduct the pension levy of 0.6%pa leaving a net advantage of around 1.4%pa.

1 Source: [broken link removed]


----------



## igloo (2 Oct 2012)

Thanks for responses.  I think the key point here is that contributions paid while out of the workforce may be carried forward and used against future earnings on return to paid employment.


----------



## MugsGame (27 Dec 2012)

Marc said:


> a taxpayer is entitled to tax relief on a contribution of €1,525 paid even if this exceeds the normal income-based limit.



Does the €1,525 minimal relief still apply in the case of an adult on long-term disability benefit, who is not expected to ever earn taxable income?



> A contribution not allowed in one year because it exceeds the age or income related limit may be carried forward and relief allowed in subsequent years.



Does this carry forward only apply to the income related relief? i.e. if contributions are ceased or reduced, can the €1,525 minimal relief in this and subsequent years also be allowed for tax relief against a larger contribution in previous years?


----------



## Baracuda (2 Jan 2013)

Marc there is a lot of unknown's in your inheritance tax solution that may make this a very costly mistake

Firstly the grandchild would have to have the €3000 lodged into their own account as a PRSA needs to be funded by the beneficiary to avail of tax relief, so this could be an issue straight away.

Lets assume that the grandchild starts their working life at 20 on an income of €25,000 and will get tax relief @ 20% for the full €3000 PRSA gift so that's €600 up front this year..Thanks for the gift grand parents!

The grandchild cannot access this money for at least 30 years and most likely 48 years at NRA.

For the following example let me make a few of the following assumptions.
No "real growth" only inflation growth so the €3000 is still €3K in todays terms. Tax rates, bands etc are still the same in real terms. Marginal tax rate of 41%

Total Gross investment €3000
Total Net investmet €2400

Draw down method ARF

TFLS €750
Remaining fund €2250
tax@41% €922.50
USC@7% €157.50
PRSI@4% €90.00


Total deductions €1170.00

Net remaining fund €1080
TFLS €750

Total of €3000 gift after 48 years after all taxes deducted including tax relief refunded 48 years ago €2430. That is a major loss in real terms.

Would it not be better to gift an investemnt in something that has a maturity date of 5 to 10 years such as solidarty bonds where the returns are currently inflation beating and broadly tax free?


----------



## Marc (2 Jan 2013)

Barracuda,

Thank you for your analysis.

I agree that if a parent or grandparent wants to make provision for a child's or grand child's *immediate* requirements then funding a pension is certainly not the way to go. Naturally paying for weddings, university and deposits on a property is best achieved through deposit accounts.

However, let's assume a world, as I did, where parents and grandparents wish to make provision for their children's *future*

I actually remember getting money when I was 18 and again at 21 and I can assure you that I have absolutely nothing to show for it. That is pretty much how I would define one of the most important lessons I ever learnt about money.

So, the need to make long term provision is difficult enough and the majority of us just out of school or college lack the financial maturity to make the difficult choices about our future. 

This is where parents and grandparents can help us to start making difficult choices about provision that we would otherwise prefer not to do and indeed some advisers are reluctant to approach.

The benefit of pension provision made at an early age is based on nothing more than compound interest. I would dispute unreservedly your assumption of zero real return on capital as an unrealistic assumption for anyone with a competent pension adviser.

The equity risk premium for the last 100 years has averaged a real 4%pa in most developed nations.

Even if we assume a real return of 2%pa net of charges and a term of 30 years that still makes the original net contribution of €2400 worth €4347.27 after 30 years and €5,299.30 after 40 years. Plus €600 income tax rebate upfront.

Remember that the gains are free from personal taxes of income tax, capital gains tax, exit tax and DIRT.

If we assume tax free cash of 25% of the fund after 40 years that would be €1324.75 in your hand tax free with the balance of the fund (€3974) available to provide a pension which even if you took as a taxable lump sum subject to 52% tax would still net €1907 net, plus the €600 you got in income tax relief up front total on these assumptions of €3831 from an initial investment of €3000 that you got as a tax free gift.

I agree with you that there is lots of uncertainty in planning for the future but this doesn't look like such a bad deal to me.


----------



## Baracuda (9 Jan 2013)

Hi Marc
I would say that yes this could be a good idea in certain circumstances and it would have the added side effect of encouraging the grandchild to save for their retirement if they had a base fund to build on,

I do have an issue with using “positive only” compounding which you have used in your example, I have been complaining at work about this for the last couple of years as I now believe that this is very misleading when investing in volatile assets such as managed funds etc 

Pension companies, fund managers, investment companies etc. etc. have for years imo provided an extremely poor projection tool to the consumer by using positive only compounding projections. When these companies provide projections they use various percentages for different asset classes which are capped by the CBI and this assumed growth rate is nicely compounded by up to 6% for managed funds year on year. This is an unfair practice to the consumer and sets an unreal expectation that can and does cause complaints during the life of the pension.

In the real world it does not work like this, investments performance may go down as well as up, remember if an investment falls by 50% (which they did and more for certain funds between late 2007 to early 2009) it then needs to go up by 100% to get back to where it was! 

Looking at average manager past performance returns for the last 10 years, the average manager “point in time” return has been about 3.8%p.a. before AMC. Inflation over the same period has been about 2.5% averaged or so, it would appear that a person’s pension fund has only broke even in real terms taking account of a 1% AMC..right???

Wrong I am afraid, in fact if you look at the average regular monthly premium pension for the last 10 years you would see that they are showing a loss of circa 10 to 20%. This is because of euro cost averaging, where you buy units through all market conditions so you have paid the average price over that period. Unfortunately fund managers are reluctant to release this data , it rarely looks as good as the usual “point in time” past performance figure.

I certainly don’t mean to turn people off pension funding and euro cost averaging can work very well. A good example of this was the period from 2001 to 2007 which was when the SSIA were around. There was a bear market for the first couple of years which was followed by a strong bull market and as a result these non deposit SSIA's performed exceptionally well.


----------

