Two lads were standing at the bar of a Friday night in October....their kids put to bed, they gather for their monthly 'Fischers Friday' in their local pub!
Lad #1: "Hey, they're telling me I should do this AVC pension in work"
Lad #2: "Whats an AVC?? Sure do you not have a pension already in work?"
Lad #1: "Eh, yeah I do yeah but yer one said I should set up this other one to give me more of a lump sum in 20 years!"
Lad #2: "Sure jaysus you could be dead in 2, whats the point in doing an ABC or AVC or whatever it's called?!"
Lad #1: "Yeah but she said that if I don't do it i'll miss out on a load of tax reliefs or somethin"
Lad #2: "Tax relief me eye, sure if you put it all into the ABC thing you'd not be able to afford these pints your about to buy!"
Lad #1: "Ha! But yer right, sure yer one was only trying to sell me stuff I suppose"
Lad #2: "Damn right she was, them ones are all the same, pushy pushy, only interested in themselves, ya may tell her to shove her ABCs!"
This wasn't our attempt at a Roddy Doyle sketch, moreso our interpretation of what we believe probably crosses people's minds when they are invited to look at AVCs! They might not verbalise it but they probably think it.....and to a degree they wouldn't be totally wrong!
This week we were contacted by one of the national papers for our comments on AVCs; the pros and cons as it were. We gladly gave our views, and though it wasn't on the agenda this week we decided to do a piece on AVCs.......it's over-due in fairness! We are hoping to dig into the ABCs of AVCs a little, keeping it simple and looking at it slightly differently, as we do!
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So how about we look at that wee conversation above and take it line by line, figure out how right or no they are! Before we begin, in order for an AVC to be of any appeal to you, you need to have A) an understanding of what it is B) clarity on how it will benefit you (or not) in the long term & C) the disposable cash to put into it!
What is an AVC? Sure don't you already have a pension in work??
So if you work in a job and you are a member of the pension scheme, an AVC may apply to you. If you don't work, or if you do but there is no pension scheme then it's probably fair to say that AVC's don't apply to you, so stop reading and head over here instead!!
Your employer is likely to be making contributions into the main company scheme, and indeed you may be making contributions yourself in one way or another, all adding to the size of your pension 'cake'! However the contributions being made between you and your employer may be below the maximum amounts allowed by the Revenue Commissioners. That is why these separate arrangements called AVCs were created.
AVC itself stands for Additional Voluntary Contribution and essentially is another pension product/contract that you could enter (basically it is a PRSA!). Just as your main scheme pension is a pension, your AVC is a pension. The money in your main scheme needs to be allocated to some sort of a fund, your AVC is the very same. Generally you'll be given the option of 'Low/Medium/High Risk'. Needless to say please check out here if you want some idea of our thoughts on all of that!
Your employer scheme may have the option of doing an AVC as part of the overall scheme, or else you can do a personal AVC, in the form of a PRSA AVC.
Lad #2 was spot on, Lad #1 is already a member of a pension scheme in work, but there may be scope to have another one!
"Eh, yeah I do yeah but yer one said I should set up this other one to give me more of a lump sum in 20 years!"
Beginning with the end in mind, we need to ask 'What is the point in doing an AVC'!? As we saw earlier these AVCs were made available in the first place to allow people to increase their pension provision allowable under revenue rules. Oh, and don't forget if you are retiring after 2028 it'll be 68 before you get the State Pension....just thought we'd throw that out there again!
What's the point in doing something if you have no idea what it is actually going to do for you! We saw in this blog how you actually go about taking the benefit from an occupational pension scheme, be it Defined Benefit or Defined Contribution.
We saw in that 'how do i take my pension benefits' that the ways of taking your pension cake and eating it are one or a combination of:
Lump Sum of Tax Free Cash, Buy A Pension (Annuity) or Move Money To An ARF.
So what difference will having an AVC make to your cake eating?? The logic of doing an AVC in the first place should be built on availing of one or more of these options. For example, if your projected lump sum in your main scheme was going to be less than €200k (Revenue max limit on tax free cash), then you could use an AVC to increase the amount of tax free cash you were going to get at the point of retirement.
The thoughts of getting tax free ANYTHING is pretty sweet, so this option above is quite the popular one! However other than the Tax Free Option there is also the option of having a larger cake with which to buy an actual pension (the act of handing over all your pension money to an insurance company and they drip-feed a certain amount to you each year). It stands to reason that if the cake is bigger the size of the slice you get each year will be bigger (keep an eye out for an annuities episode coming soon!).
Finally of course there is the whole idea of moving money to the ARF, which we feel is akin to putting that lovely big cake into your own cake tin, and taking as you wish. Again, if that makes no sense then please do pop over here for some clarity!
As for Lad #2's point that Lad #1 could be dead in 2 years....he's not wrong there....any of us could at any time....but if your AVC going missing is a fear you have then it is an unfounded one. Any and all funds that are in your scheme or AVC will be included in your estate and dealt with as per the terms of your Will & the Succession Act.
"Tax relief me eye, sure if you put it all into the ABC thing you'd not be able to afford these pints your about to buy!"
Tax relief really is the main incentive for doing a pension. If there was no tax relief you'd be as well off putting the money into a non-accessible deposit account or investment fund.
There are lots of folks who have money sitting in deposit who are complaining about the deposit rates, but who do not want to invest it over the longer term to retain the purchasing power of their money. Many such people may also have access to doing AVCs, and availing of the very very generous tax reliefs available! Would you like 40% return on your investment in the year you invest it??? I think you would!
Imagine you had the option to do an AVC. You also happen to have €50,000 savings in your bank account. You are getting 0.0000000000001% (!) on your bank account, you're not happy! You are 42 years of age, and have been a member of your pension scheme in work for the past few years. There is €170 per month being invested each month into your pension. The conservative fund you have opted for has been performing OK, you now have a fund of €5,000 in this Defined Contribution Scheme.
You say your plan is to retire in 20 years. Your pension pot, assuming it grows at 4% per year (after all fees & charges!) and the contributions remain at €2,000 per year, you should have a fund of €740,000 at your chosen point of retirement! Happy Days!
However if you recall we said you can take 25% of your fund, or up to €200,000, tax free cash at point of retirement. You decide to make an AVC contribution of €10,000 to try bring that tax free lump sum upwards and nearer that €200,000.
By making the €10,000 contribution (which came from your deposit account remember), you will receive a tax credit for that year of €4,000, your tax bill for the year will be €4,000 less than what it would have been. In simple language you will take home €4,000 more in Net Pay than you would have had you left it in the bleedin bank! In addition to that you'll now have a more generous lump sum in 20 years time assuming you have a competent advisor to help you not make any silly mistakes along the way!).
As a someone in your 40's you are allowed, again under Revenue Rules, to contribute 25% of salary each year into a pension, and get tax relief at your 'marginal rate'. In this instance you are a higher tax rate earner, so get that rate of tax relief (40%!).
Lad #1 got the key message that there may indeed be highly valuable tax relief to be availed of. Depending on his circumstances it might indeed be a cracking thing for him to do. For what it is worth this is what financial planning for millennials in Ireland should look like.....!
"Damn right she was, them ones are all the same, pushy pushy, only interested in themselves, ya may tell her to shove her ABCs!"
Advisors tell people to do things all the time. There are literally 100's of advisors meeting 100's of clients every day of the week here in Ireland, and advisors are telling them to do things with their money. That is what 'advisors' do isn't it, the clue is in their title!? That is what they are being paid to do? Yes indeed.
However, it is unfortunate that the financial services industry has been plagued with such ill-trust (most of it fully deserved in fairness!). This mistrust has people questioning the motives behind them, for example, being told/recommended to do an AVC, even if they can clearly see the benefits of it in front of their own eyes! Our industry has a long way to go to regain trust, in being more transparent about how they are paid and the charges that are being collected on AVCs and all other contracts.
However, none of that takes away from the fact that for certain people an AVC is an absolute no-brainer. For some it is the absolute right thing to do, even if the advisor is getting a commission if the person goes ahead with it! For others it is not the right thing to do, or it may not be the right time, or there may be better options which need to be explored first (such as buying back years/ Notional Service Purchase if in the Public Sector).
AVCs might turn out to be a compete waste of time for you, or indeed they might turn out to be a super option for you.....but please don't let the negative 'Lad #2' thoughts put you off the idea of at least finding out for yourself.
Thanks so much for reading.
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