AVCs vs Investing outside of pension fund

Hi,
I am a member of a Defined Benefit Scheme. I am entitled to a lump sum amount at retirement age 65 years old of around €59k but this means that annual pension payment will be reduced. I do not wish for the annual payment to be reduced and so I am contributing to AVCs. But I have been told by the pension administrators that regardless of size of my AVC pot, the lump sum that can be withdrawn tax free will still be €59k. And the balance of the AVC pot can be (1) withdrawn with tax implications or (2) has to be contributed to an ARF and a notional 4% annually will be calculated for tax deductions. If I carry on investing AVCs to the max till I am 65 years old, I will have circa €300k in the AVC pot. And if I can withdraw tax free only €59k from the AVC pot, that means that 4% of €241k (ignoring any growth) will be subject to tax annually possibly at marginal tax rate as I will be getting the defined benefit pension and the state pension as well. My question is whether I would be better investing the money to an index tracker or buy shares instead of continue to contribute AVCs. I am attracted to AVCs due to the tax relief. But now that I have found out that the tax free lump sum that I can withdraw is only €59k, I am unsure of what to do. Would appreciate some advice. Thanks.

The maximum retirement lump sum (under Revenue rules) is 150% of Final Salary but subject to having completed at least 20 years service. However your particular Scheme may not pay that, particularly if you have short service.
So, how was the €59k figure calculated? How many years service will you have by age 65? What is the Salary?
The most tax-effective use of the AVC pot is to bridge any shortfall between what the scheme will pay as a lump sum and the Revenue maximum figure.
Any balance in the AVC pot then can be used either:
- to buy an Annuity (additional pension for life), or
- invested into an ARF, from which you must draw down a minimum of 4% pa.

From your mail I suggest you need professional advice. If your marginal income in retirement is going to be taxed at marginal rate, it might be sensible to cease investing AVCs. There is not much point (tax effective) in building up an AVC fund if the income/Pension from that fund is going to be taxed at marginal rates. You get 40% relief on the AVC contribution but might be taxed at 40% + USC on the eventual income.

Thanks Conan. But how I do this that you mentioned in your reply:

“The most tax-effective use of the AVC pot is to bridge any shortfall between what the scheme will pay as a lump sum and the Revenue maximum figure.”

How do I increase my tax free lump sum from €59k to €200k if I am in a Defined Benefits Pension scheme (besides increasing my salary immensely, too late to consider increasing length of service)

I rang the Pensions Authority but they were of no help. They told me to ring the Revenue instead.

The maximum lump sum is 150% of Final Salary. You say that you are entitled to €59,000 from your Scheme, but is that 150% of Salary? If the €59,000 is less than 150% of Salary AND assuming you will have at least 20 years service by retirement, then you can build up an additional pension fund (via AVC’s) and use such fund to bring the €59,000 up to the 150% figure.
The €200,000 figure is a separate figure. If the 150% produces a figure of higher than €200,000 (if your Salary on retirement exceeds say €133,000), the first €200,000 is Tax-free (any excess up to €500,000 being taxable at 20%).
So:
- will you have more than 20years service by retirement age?
- what is your expected Salary at retirement?
- how was the €59,000 arrived at?

Hope this helps.

My final salary will be €80k per annum.
I will have 17 years service with my current employer when I retire at 65. But I would have worked in full time employment throughout my life for more than 20 years. 2 of my previous employers would provided Defined Benefit schemes and 1 employer a Defined Contribution scheme.
The €59k is calculated based on my final salary, years of service with current employer and is 25% of the total fund - I am assuming this as the administrator has not yet replied to my question.

So how do I increase my tax free lump sum? A PRSA? Or contribute to AVC with previous employers?
Thanks.

Your initial post said you will be retiring from a Defined Benefit scheme. Therefore the 25% of fund mentioned in the most recent post cannot be correct. The 25% applies only to Defined Contribution schemes.
If you are retiring from current employment in a DB scheme then the Revenue maximum lump sum with 17 years service is 90/80xFinal Salary. But the scheme rules may only provide a lower amount. Perhaps that’s where the €59k comes from.
In respect of this employment it is service with that Employer that counts. So 17 years is the figure. Benefits from previous employers are a separate issue.
Based on the above it appears that you could (under Revenue rules) get a lump sum of c€90,000. If the scheme Rules only give you €59k, then there seems to be a potential shortfall of c€31k. You might be able to fund that shortfall by means of an AVC (either under the rules of the Main Scheme or by means of a stand-alone PRSA AVC).
Clearly bridging the shortfall, in full or in part, is tax-effective in that you can get tax relief on the AVC’s (perhaps at 40%) and get the total AVC fund back as an additional tax-free lump sum on retirement. AVC’s can only be made in respect of your current employment.
So I think you need to clarify with the Scheme Administrator that you can invest AVC’s and that there is a potential shortfall of c€31k. I don’t understand how the Administrators say that your max lump sum is €59k. That may be the figure under the scheme rules, but under Revenue rules you could get 90/80xFinal Salary (with 17 years service).

Pursue the issue with the Administrator.

Thanks Conan. That has clarified a lot of things for me. Regarding my other employments, can any tax free lump sums be calculated from those pension schemes? If yes, should I contribute my AVCs to a PRSA outside of my current employers pension scheme?

From my experience, scheme admins do not always quote the max available lump sum under revenue rules but a request to do so may well be granted at the discretion of the trustees/employers.

Some consideration to the 2 previous DB schemes may also be useful, assuming they were not transferred into your existing scheme.
Under the revised rules from 2016, a retirement bond from those schemes could avail of the 25% tax free lump sum as if they came from a DC scheme.