AVC Contribution Strategy

[Ent319]

In a previous thread that I can't link to for some reason (see: "Understanding Scope for AVCs in Integrated Defined Benefit Pension"), I tried to suss out the scope for AVCs in my pension scheme. The new Single Public Service Pension Scheme is not a "final salary" scheme. Rather, pension entitlement are built up over the course of your career as a proportion of your salary at various snapshots in time. This makes calculating your future benefits quite difficult.

The two main gaps that can be filled by AVCs from my scheme are:

- The value of the State Pension (circa. €12,700 pa). The capital value of this for an unmarried male would appear to be roughly €230,000, increasing to €330,000 when married.
- Gaps between my actual benefits accrued vs. the maximum benefits I'm entitled to under revenue rules from an increasing salary over the course of my career. For example, if I spent the first twenty years of my career at €50,000 Salary, I would accrue approx €6150 referable pension + lump sum. If I spent the next twenty years of my career at €100,000 Salary, I would accrue approx €18650 referable pension + lump sum. Total referable pension in this scenario would be €24800. However, my maximum referable pension could be €50,000. Therefore, there would be an approx €25,000 pa shortfall that could be made up by AVCs. This is quite an extreme example, and the maths may not be completely right, but it illustrates the point. Gaps in maximum entitlements are created over the course of your career through a rising salary.

I've a few questions:

1. Am I correct in assuming that when calculating the capital value of an AVC Pot to determine revenue pension benefit limits, contributions and the growth of the value in the pot from being invested are both taken into account?

2. I've done a bit of searching but I've found it difficult to find a clear source on how "final salary" is defined. This is key to determining what your maximum benefits are under revenue rules. Can anyone help?

3. This will likely depend on the answer above, but: can you end up getting caught out by the definition of final salary if your salary drops later in your career? For example, let's say someone spends the first thirty years of their career at €100,000 salary. They accrue pension benefits with this final salary in mind. Then, for the next ten years of their career, they go part time or they get a new job and are paid €50,000 pa before they retire. The person might have built up pension benefits at the €100,000 salary rate over their life, but their final salary is much smaller. What happens if the person has accrued more pension benefits than they might be entitled to on the basis of their final salary? Again, slightly extreme example, but it illustrates the point.

4. Pensions benefit from a "loan" of income tax from revenue and compound growth that doesn't get hit by the deemed disposal rule. This makes them desirable for investing even if you're in the 40% tax bracket when you retire (there's a bit of debate to be had on this, but it seems fair imo). For someone who knows that there'll be a definite gap in maximum entitlements from (i) an amount of referable pension equivalent to the State Pension and (ii) gaps in pension entitlements generated over the course of your career, what might be the best strategy for contributing to an AVC? Here's three options for discussion:

• Go Big or Go Home. Max your pension contributions as much as you can early on within reason. Taper off and tune contributions later on.
• Balanced Approach. Try to achieve a reasonable balance between availing of contribution incentives and maximising growth through investment, hopefully aiming for something close to final salary towards the end of your career.
• Low and Slow. Make reasonable, small contributions throughout your career and then ramp up towards the end to meet deficits in maximum entitlements.

5. I understand that a pension scheme's trustees are responsible for ensuring an AVC isn't overfunded. How does this work in practice? Will you get a call saying there's a danger of an overfund?

Again, I'm posting this in the general pensions forum rather than public sector pensions forum as the same principles will apply irrespective of whether the pension scheme is public or private.

 

[Conan]

In response to your questions:
1.The value of the AVC pot is the value (contributions plus growth) at retirement age.
2. Final Salary can be defined as the higher of:
- The final years salary (including any bonuses, BIK etc)
- The average of the last three years income
- The average of the three highest consecutive years income ending not earlier than 10 years prior to retirement. In addition, the resulting figure can be indexed (based on CPI) up to retirement age.
3. In a traditional DB scheme, the benefits are calculated on the basis of the Final Salary as per the scheme rules. In the Single Scheme it’s the yearly accrual basis, though Revenue rules still apply.
4. I would favour the Balanced approach. However it is important to review the contributions, fund performance etc every few years to make sure you won’t exceed the Revenue limits ( though it’s actually hard to exceed the limits if you are in an integrated, average salary scheme).
5. Technically the Trustees are responsible for ensuring that you don’t exceed the Revenue limits. However in practice in the Public Service Scheme does not have Trustees. You would need to liaise with your HR/Payroll people in the run into retirement.
Hope this helps.

 

[Ent319]

1.The value of the AVC pot is the value (contributions plus growth) at retirement age.

Very clear. Thanks.

2. Final Salary can be defined as the higher of:
- The final years salary (including any bonuses, BIK etc)
- The average of the last three years income
- The average of the three highest consecutive years income ending not earlier than 10 years prior to retirement. In addition, the resulting figure can be indexed (based on CPI) up to retirement age.

Just to be crystal clear here: point three means the average of any of the highest three consecutive years more than 10 years before retirement? So for example, if when I'm 40 I do a job for three years that pays €100k Salary, that can be used to determine my "final salary" (adjusting for inflation) twenty years later, even were I to retire in a job at a lower salary?

3. In a traditional DB scheme, the benefits are calculated on the basis of the Final Salary as per the scheme rules. In the Single Scheme it’s the yearly accrual basis, though Revenue rules still apply.

That's helpful. My third question doesn't really matter because the concept of final salary was more flexible than I initially thought.

4. I would favour the Balanced approach. However it is important to review the contributions, fund performance etc every few years to make sure you won’t exceed the Revenue limits ( though it’s actually hard to exceed the limits if you are in an integrated, average salary scheme).

This is what I would be inclined towards as well.

5. Technically the Trustees are responsible for ensuring that you don’t exceed the Revenue limits. However in practice in the Public Service Scheme does not have Trustees. You would need to liaise with your HR/Payroll people in the run into retirement.

Grand.

Hope this helps.

Huge help. Thanks very much.

 

[Conan]

The third option in point 2 means "ending not earlier". So if you were retiring at age 65, you could average salary at ages 55, 56 and 57.

 

[Ent319]

Ah OK - that's a little bit less flexible then. Thanks for clearing that up.

Final question: under Chapter 5 of the revenue pensions manual, the capitalisation factor that determines maximum pension benefits available for married people is higher than that for non-married people. In the last thread, I think it was explained that this was to allow for the funding of the spouses pension. If a married person's occupational pension doesn't provide for a full spouses pension, does this mean that the gap created can be funded via an AVC and be spent on whatever?