Surplus AVC

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garryb

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When you retire, and taking the maximum amount allowable tax free out of an AVC, the remainder can be put into an ARF. Is it possible instead to take the remaining amount out instead of putting it in an ARF and pay tax on that amount. Would you also have to pay USC and PRSI on this amount?
 
The AVC fund must be linked to the main scheme. So AVC benefits must be taken in conjunction with the benefits under the main scheme.
Assuming the AVC pot is used initially to top up the retirement lump sum from the main scheme to the Revenue maximum, any excess can be either:
- used to buy an additional annuity
- invested into an ARF, OR
- taken as income in the year ( which will be subject to Income Tax, USC and possibly PRSI if under age 66).
 
I am trying to work out different scenarios to find out how much is too much AVCs. Even with the tax relief received for contributions, I am guessing that it is not always wise to contribute to the max because if there is a huge surplus after the tax free lump sum, then further amount taken as lump sums will be taxed, or if AVCs are transferred to an ARF there will be notional 4% that is taxed every year. Without working out different scenarios, is there a general guideline that we can use in terms of how much is too much AVCs vs say contributing the surplus to a unit linked fund and getting taxed at 41%? How does it differ for a retired person is taxed at 20% vs 40% income tax? Thanks.
 
The most tax effective AVC investment is where you can use the full AVC fund to augment the scheme retirement lump sum (in a DB scheme) up to the Revenue maximum. So for example if you have only 30 years service, the scheme lump sum might be 30x3/80ths of Final Salary, but the Revenue limit is 150% of Final Salary (so long as you have a minimum of 20 years service). So building up an AVC pot of an additional 30/80ths is very tax effective, in that you get tax relief on the contribution but pay no tax on drawdown of the AVC pot.
As you correctly point out if there is an excess beyond the above, then potentially there the tax benefit is reduced or non-existent. If you get 40% tax relief on the contributions but expect to pay 40% Income Tax (plus USC) on the resulting additional pension income (either drawdown from an ARF or from an additional Annuity) then there is no tax benefit. Arguably not worth funding in excess of maximizing the tax-free lump sum.
However if your marginal tax rate in retirement is going to be 20% or zero, then it can be a sensible strategy.
 
Apologies for the simple example...

If someone is on €80k a year and has 20 years’ service, ordinarily the lump sum will be €60k.

If he/she puts €60k into an AVC fund, is it then possible to get that tax-free as part of a €120k lump sum?

And when is it paid, at retirement or at NRA? The latter presumably, unless the person takes early retirement (and suffers some form of actuarial reduction)?
 
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Firstly, the Revenue maximum retirement lump sum is 150% of Final Salary, subject to having completed at least 20 years service at retirement.
If the above calculation exceeds €200k, the first €200k is tax free, with any excess taxed at 20% (up to an excess of €300 - so a total of €500k).

Gordon - your calculations are correct. That’s where AVCs make sense.
The lump sum ( including any additional lump sum from an AVC pot) is payable on retirement.

Moneymakeover- the absolute limit (assuming we are talking about a DB scheme) is 150% of Final Salary. You cannot fund for a retirement lump sum in excess of this figure irrespective of how it is taxed.
 
Thanks Conan. I’m confused; on retirement or at Normal Retirement Age?

e.g. does a departing 50 year old on €80k a year and with €60k worth of AVCs get his/her €120k immediately, or does he/she have to wait 10 years until NRA?

I thought all that Cost Neutral Retirement stuff would kick in.
 
In my case, defined contribution,

So first 200k tax free
Subsequent 300k @ 20%

If I exceed 800k (!) there are still tax benefits

But to max the tax benefits I should target 800k
 
Gordon Gekko said:
Apologies for the simple example...

If someone is on €80k a year and has 20 years’ service, ordinarily the lump sum will be €60k.

If he/she puts €60k into an AVC fund, is it then possible to get that tax-free as part of a €120k lump sum?

And when is it paid, at retirement or at NRA? The latter presumably, unless the person takes early retirement (and suffers some form of actuarial reduction)?
Click to expand...

Can I get some clarification please. In this example, is €60k tax free and another €60k at 20% tax?
 
I think I got that wrong. Salary at €80k with 20 years service means tax free lump sum is €120k. And if DB scheme only gives out €60k then another €60k can be taken from AVC also tax free.
 
This thing about 20 years service allowing 150% of final salary perplexes me. What if in your final job before retirement you only have 1 year of service but in your whole life you have worked more than 20 years? How do you calculate the tax free lump sum then?
 
Gordon Gekko said:
Thanks Conan. I’m confused; on retirement or at Normal Retirement Age?

e.g. does a departing 50 year old on €80k a year and with €60k worth of AVCs get his/her €120k immediately, or does he/she have to wait 10 years until NRA?

I thought all that Cost Neutral Retirement stuff would kick in.
Click to expand...

In the Public Service, at least, the departing 50 year old would not get €120K if taking cost neutral early retirement. Even if he/she had more than €60k in the AVC fund to "compensate" for the actuarially reduced PS lump sum, it still would not work. The 150% of final salary tax free is reduced as well if taking cost neutral early retirement. I don't recall off hand what the reduced percentage (per year) is. I assume that if the retiring 50 year old opted for a preserved pension they would get the €120k at 60 - although charges may somewhat deplete the AVC fund in the meantime.

A pre 2004 PS can (not must) retire from 60 without actuarial reduction. Your example could only apply in the PS to a pre 2004 entrant. For post - 2004, cost neutral retirement is only available from 55 with NRA at 65. There are exceptions (eg Gardai).

I assume similar would apply to a DB scheme in the private sector - if the scheme allowed cost neutral early retirement.
 
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So many questions.
Gordon- the 150% max after a minimum of 20 years applies on normal retirement age. If one is retiring early, then the calculation is a little more complicated and will be reduced somewhat.

Moneymakeover- in a DC scheme the individual can take a retirement lump sum of either 25% of the Fund of up to 150% of Final Salary (assuming at least 20 years service) BUT in such a case the residual fund must be used to buy an Annuity (not invested into an ARF). If you go the 25% route (so €200k) and have a fund in excess of €800k, any additional lump sum is taxed at 20%. But that may still be good if the alternative is additional pension income taxed at 40% plus USC. But it is arguable if it is worthwhile the member contributing further contributions prior to retirement to exceed the €800k as any excess will generate an additional 25% lump sum taxable at 20% plus pension income on the excess 75% taxable at 40% plus USC.

Pieface- if the salary is €80k with only 20 years service and the scheme lump sum (typical Public Service DB scheme) is therefore 60/80ths, then yes the individual could fund for an additional 60/80ths through an AVC fund.
The 20 year minimum requirement for the max lump sum is based on the job you are retiring from. If you only had 1 year’s service in your last role, then you are very very limited in what pension benefits can be provided from that employment. But presumably you may have pension benefits from previous employments. Options there will depend on a number of variables.
 
If tax free lump sum is €120k (150% of final salary), how will the remainder AVCs be taxed if taken as out a lump sum too? I know it’s tax free till €200k and then 20% to €500k. But in this instance, is it the next €300k (121-421)at 20% or is it €121-500 at 20%? If I am going to be a 40% tax payer when I retire, it might still be worthwhile to take lump sum at 20% tax? I am still trying to figure out how much AVCs to contribute going forward.
 
Pieface said:
If tax free lump sum is €120k (150% of final salary), how will the remainder AVCs be taxed if taken as out a lump sum too? I know it’s tax free till €200k and then 20% to €500k. But in this instance, is it the next €300k (121-421)at 20% or is it €121-500 at 20%? If I am going to be a 40% tax payer when I retire, it might still be worthwhile to take lump sum at 20% tax? I am still trying to figure out how much AVCs to contribute going forward.
Click to expand...

My understanding is that any AVCs in excess of the 120k given in your example cannot be taken as lump sum and instead an annuity/ARF must be purchased.

I am pondering the same question as you though, at what point does it no longer make sense to pay into an AVC
 
Gordon Gekko said:
e.g. does a departing 50 year old on €80k a year and with €60k worth of AVCs get his/her €120k immediately, or does he/she have to wait 10 years until NRA?

I thought all that Cost Neutral Retirement stuff would kick in
Click to expand...

Gordon, From looking at the Tax and Duty Manual (Revenue) I think your 50 year old in this example would be limited to a tax free lump sum of €80000. This is calculated as €120k*20/30, where €120k is the maximum receiveable, 20 years the actual length of service and 30 the potential service to NRA. See Section 9.4 :

https://www.revenue.ie/en/tax-professionals/tdm/pensions/chapter-09.pdf
 
Pieface
If in your example the max lump sum is €120k, then any excess funds in an AVC pot must be used to either
- buy an Annuity, or
- invested into an ARF
Drawdowns from the ARF (minimum of 4% pa) are taxed as income (income tax plus USC). You can draw down an income gradually or you could draw down the full amount, but either way the drawdown is taxed as income in the year.
It’s only tax-free up to €200k if the 150% of Salary exceeds €200k. So if you retired on a salary of €160k, you could potentially get a retirement lump sum of €240k, the first €200k of which is tax free with the remainder (€40k) taxed at 20%. So in your example, the retirement lump sum is limited to €120k, end of. Any excess funds, even if drawn down immediately are taxed at marginal Income Tax (not 20%).
So as I said earlier, it is questionable whether it is tax effective to contribute AVCs which if converted into income would be taxed at 40% Income Tax plus USC. Using AVCs to maximize the retirement lump sum makes sense.
 
Early Riser said:
In the Public Service, at least, the departing 50 year old would not get €120K if taking cost neutral early retirement. Even if he/she had more than €60k in the AVC fund to "compensate" for the actuarially reduced PS lump sum, it still would not work. The 150% of final salary tax free is reduced as well if taking cost neutral early retirement. I don't recall off hand what the reduced percentage (per year) is. I assume that if the retiring 50 year old opted for a preserved pension they would get the €120k at 60 - although charges may somewhat deplete the AVC fund in the meantime.

A pre 2004 PS can (not must) retire from 60 without actuarial reduction. Your example could only apply in the PS to a pre 2004 entrant. For post - 2004, cost neutral retirement is only available from 55 with NRA at 65. There are exceptions (eg Gardai).

I assume similar would apply to a DB scheme in the private sector - if the scheme allowed cost neutral early retirement.
Click to expand...

I was sold AVC's on the understanding that if I choose to retire early under cost neutral conditions after 20years service I would be able to bump up my lump sum to 150% of salary. According to the above that's not the case?
 
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