Public Sector AVC's
We offer AVC Advice for Teachers, Nurses, Gardaí, or any other public sector profession.
AVC’s are a simple and tax efficient way of saving for your retirement. They are extra contributions made to increase your pension. The main advantage of AVC’s is that the employee gets income tax relief on contributions into an AVC. The question that many people forget to ask themselves is, will I be faced with a tax bill on retirement.
Many public Sector employees have mixed experiences in relation to AVC’s. Some have used their AVC’s to maximise their tax free lump sum and as a result were able to withdraw all of their fund tax free on retirement. Others have had to pay up to 52% tax on their funds on drawdown as they were overfunded.
AVC’s…Why? Can I Retire Early?
AVC’s are very popular within the Public sector. The main reason for this is that employees think they can retire early by using their AVC. They paid into AVC’s for the purpose of purchasing notional years service using these funds. This is true however, what people didn’t and still don’t realise until it is too late is that the cost of buying back even one year of service is usually so expensive that it does not make much financial sense to do so. It can cost anything from €13,000-€20,000 for one year (depending on their age and salary). The pension benefit of buying this year only represents a minimal increase on the employees final tax free lump sum and pension income. As a result, many civil servants have found themselves with excess money in their AVC that they cannot get out tax free nor can they buy back as many years of service as they thought. This is why AVC’s have such mixed reviews in the public sector.
When should you pay into an AVC?
The main reasons civil servants should pay into an AVC is to fund for the maximum tax free lump sum available. If you have less that 40 years service on retirement, You will have a tax free lump sum shortfall and will have a significant AVC requirement how much this shortfall is depends on your final pensionable salary and years of service accumulated at your retirement date. Calculations are needed here to find out the optimal amount of money needed in your AVC.
Below is a video explaining Public Sector AVC’s.
If you are;
- Thinking of starting an AVC
- Thinking of stopping contributions into your AVC
- Thinking of restarting your contributions
You need to get some financial advice to assess your options to make tax efficient decisions. Finding out your estimated tax free lump sum shortfall is a must (if you have one at all) before you ever start an AVC.
Do you know your shortfall?
Thinking of starting an AVC?
If you are thinking of starting an AVC, before any contributions are made it is important to find out what, if any is your tax free lump sum shortfall. If you do, it is important to have a rough estimate of how much this shortfall is so that you can find out the monthly contributions needed to make up this amount of money over your career. Alternatively, you can contribute lump sums of money closer to retirement to make up this shortfall. These are called Last minute AVCs. (See below)
How do I set up an AVC?
There many different options in relation to setting up an AVC. You can use the AVC provider recommended by your employer/trade union or you can choose one yourself. All the relevant insurance companies provide AVCs (Aviva, Irish Life, Zurich, New Ireland Assurance etc). They all have the same revenue rules and restrictions etc.
Financial brokerage firms such as ourselves can advise you on the best product available for your specific needs and also work out how to apply for the relevant tax reliefs, the contributions you should be making and working out your shortfall. Before choosing the Financial Brokerage firm and insurance provider that you want for your AVC, you should consider the following;
- Does the broker charge a set up fee?
Many Financial Brokers charge a set up fee as high as €800. We at Money Maximizing Advisors charge NO set up fees. If the financial Brokerage firm that you are dealing with charges set up fees, locate another one.
- What are the annual management charges that the AVC provider is charging?
This usually ranges from 1-3% annually. A high management charge can significantly eat into your fund over a 10-20-year period.
- Where are my funds invested?
All insurance providers will invest your funds in one of their managed fund portfolios. Where your money is invested makes a huge difference to what your fund value will be at retirement. All AVC providers have low, medium and high-risk funds. It is important that you know what managed fund your money is invested in as these can often be high risk investment funds. The higher the risk, the higher the volatility of your money will be exposed to. Alternatively, if your money is invested in a fully capital protected managed fund, then your money can actually be eroded with high annual management charges over time as there is little or no return on investment on the majority of these low risk funds.
- What is the allocation rate provided by the AVC Provider?
This is the amount of money that the AVC provider allocates into your fund. For example, and allocation rate of 95% means that the AVC provider only allocate 95% of your money into the AVC. So, for every €100 invested, €95 goes into the AVC and the Insurance provider charges €5. Allocation rate can vary from provider to provider, it is important to get the best allocation rate available. Some allocation rates can be up to 15%.
We at Money Maximising Advisors charge no set up fees and have agencies with all the main AVC providers. We can offer the best deals, allocation rates, annual management charges and return on investments for our clients in relation to their AVC’s.
Already have an AVC?
If you already have an AVC, you may or may not be contributing into your fund on a weekly/fortnightly/monthly basis. From our experience, many public sector employees are still paying into their AVC even though they are overfunded. It is important to do your pension calculations to see if you have a tax free lump sum shortfall. Once you have this estimated number you can then compare it to the fund value of your AVC. If your AVC is lower than your tax free lump sum shortfall, then you should continue paying into your AVC. However, if you have more funds than needed in your AVC, then it may be advisable reduce or even stop your regular contributions and make the most of what you have already in your AVC fund. Please note that if your circumstances ever change, you can always restart your contributions at any time. In many cases, it is more beneficial to start a regular savings plan as opposed to continue contributing into an overfunded AVC.
Making the most of your AVC Fund
If you have accumulated a pot of AVC money and you then realize that you are overfunded and have stopped contributions, it is important to manage this fund properly so you make steady returns over the lifespan of your career and that Annual management charges don’t erode into the fund over time. From our experience many clients do not stay in touch with the performance of their AVC fund and as a result don’t maximize the potential of their AVC moneys earnings potential. Your fund investment choice should always be at the correct level of risk that you are comfortable with. The key is to try and make steady returns in a Bull market and minimize your risk in a Bear market.
Analyzing your AVC Annual Benefit Statement
At least once a year you will receive an Annual AVC Benefit Statement of your AVC fund. Once you receive this statement it is important to ask yourself the following questions;
- What annual management charges is the AVC provider charging?
A high management charge can make a significantly negative impact on your fund value on retirement. Because you are not contributing into the pot anymore, high management charges can eat up any returns your fund is making.
- Where are your funds invested?
All insurance providers will invest your funds in their one of their managed fund portfolios. Where your AVC funds are invested makes a huge difference to your fund value at retirement. All AVC providers have low, medium and high-risk funds. It is important that you know what managed fund your money is invested in as these can often be high risk investment funds. The higher the risk, the higher the volatility of your money will be exposed to. Alternatively, if your money is invested in a fully capital protected fund (Very low risk), then your money can be eroded with annual management charges over time as there is little or no return on investment on many of these low risk funds.
- What is allocation rate provided by the AVC Provider?
This is the amount of money that they allocate into your fund. For example, and allocation rate of 95% means that the insurance provider only allocates 95% of your money into the AVC. So, for every €100 you contribute, €95 goes into the AVC and the Insurance provider charges €5. Allocation rate can vary from provider to provider, so it is important to get the best allocation rate available. We have charges as high as 17% previously with some of our clients.
Finding the above information from the benefit statement can be hard as often the charges and fee structures etc are in the small print. If you would like assistance or training on how to read your AVC benefit statement, we would be more than happy to help.
Switching your AVC to another Provider
Like mortgages, Life, Car, home insurance, it is very important to compare your AVC provider’s product with what is available in the marketplace. If there is a better deal by competitors in relation to fees and charges, Fund choices/better ROI etc, it is often possible to switch providers. Switching is not difficult or time consuming to do, if this is something which you decide to do.
Tax Free Lump Sum Shortfall explained
A tax free lump sum shortfall is where you have gap between the tax free lump sum that you will have earned by working to your retirement and what lump sum you would be entitled to if you worked full service (40 years).
The rule of thumb is;
if you have less than 40 years’ service at retirement, you will have a tax free lump sum shortfall.
If you do not have the maximum number of years’ service at retirement (40 years), then it is very beneficial to pay into an AVC to fund for your tax free lump sum shortfall. You will not pay any income tax on exit on this amount.
- If you have less than 40 years at retirement it is advisable to start contributing into an AVC.
- If you have close to 40 years service at retirement, there is no great need for an AVC…
John is a teacher on €65000 and will have 30 years’ service completed when he retires in 2 years’ time. John’s tax free lump sum will be as follows;
TFLS Formula = (No. of years service at retirement x 3/80ths) x final Pensionable Salary)
(30 yrs x 3/80th) x 65000 = €73125
The maximum tax free lump sum that John is entitled to if he worked 40 years is;
(40 yrs x 3/80th) x 65000 = €97500
John has a TFLS shortfall of €24375 (€97500-€73125).
The revenue will allow John to fund for this shortfall using an AVC.
It is very beneficial for John to pay €24,375 into an AVC as he pays no income tax on contributions into the AVC and also pays no income tax on retirement when drawing down the AVC.
In summary John’s tax free lump sum on retirement will be as follows;
John’s own TFLS (30 years x 3/80th x 65000) €73125
His AVC contributions €24375
Total TFLS €97500
By contributing to an AVC John will have saved €9750 (€24375 x 40%). If he did not contribute this amount into an AVC, he would have paid this amount in income tax from his salary.
If John starts an AVC, he will be underfunded in his AVC until he has €24375 in his AVC. Once he has more than this amount in his AVC he will be Overfunded. Every €1 over this amount will be subject to income tax, USC and PRSI.
Please note that these numbers are estimates only and with some smart financial planning, you may be able to abstract slightly more tax free from your AVC.
AVC Drawdown Options on retirement
The main AVC drawdown options available to Public sector workers in relation to AVCs at retirement are broken into two categories,
(a)The funds that can be extracted tax free from your AVC
(b)the balance of the fund that will have tax implications when extracted.
Please see infographic below
Below is a more detailed explanation of the infographic illustrated above.
(A) Withdraw your Tax Free Lump Sum Shortfall (with no tax implications)
Use the AVC fund to make up your tax free lump sum shortfall. This amount can be withdrawn tax free from the fund.
*please note that if you have over 40 years service worked you may be able to withdraw slightly more from the fund (see below for more information)
(B) Withdraw the excess of the AVC Fund
Once you have withdrawn the tax free lump sum shortfall from your AVC fund, if you have still funds in your AVC, (overfunded) then you have the following choices;
Option 1- Buy Back Notional years
Buy Back Notional Years of service to bump up your pension. This option however rarely makes sense as the cost of buying back even 1 year can be substantial (€13000-€20000 per year). The increase in your pension for this purchase is minimal so it not a viable option
Option 2 – Withdraw the money and pay the tax
Take the remaining AVC funds as a taxable cash lump sum and pay the relevant tax liability. Again, this option is rarely chosen as many public servants could have to pay up to 52% tax on the withdrawn amount as income tax (40%), PRSI (7%) and USC (4%) needs to be paid before your get your hands on this money. It is a very tax inefficient option.
Option 3 – Invest in an ARF
Invest the funds in an Approved Retirement Fund (ARF). This is the most tax efficient option at present. This is another pension vehicle that allows you to draw down the funds tax efficiently each year. With the aid of a Financial advisor, you can choose how much each year can be withdrawn without paying much tax (if any) on withdrawals. It is by far the most viable option and one which makes the most financial sense.
Other Frequently Asked Questions in relation to AVCs
What if I have over 40 years service at retirement?
If you have over 40 years service worked, then you can fund for an additional Tax Free Lump Sum using an AVC. You are entitled to take out 3/80ths of your pensionable salary tax free from your AVC for every year that you work over the 40 years. There is a cap of 5 years on this additional entitlement.
What is a last minute AVC?
A last minute AVC is where an individual contributes into an AVC in the months leading up to his/her retirement. It is used if you have a tax-free lump sum shortfall and are underfunded in your AVC. It is a fantastic tax planning tool and should be used by everyone who has such a shortfall.
For example, if John has a TFLS shortfall of €20000 and no funds in an AVC, he can contribute €20000 into an AVC and get €8000 back at the end of the year as tax relief.
If you have any questions you would like to get clarified or want to find out if you are overfunded or underfunded in your AVC, please fill in your details below and we will more than be more than happy to crunch your numbers for you.
How do I actually drawdown my AVC on retirement?
Your AVC fund is drawn down in line with your Superannuation pension. With the aid of your financial broker your drawdown forms will need to be filled out in the a few weeks before you retire from your job. You will need to calculate how much that you can withdraw tax free and then make a decision on what you are going to do with the excess funds in the AVC. You should have this completed and money received with 6-8 weeks of receiving your pension. If you are using a Last minute AVC to make up your tax free lump sum shortfall, you will receive your tax relief cheque/refund from the revenue once you complete your tax return at the end of the year.
If you are interested in Public Sector AVCs, you might also be interested in these other pages on our website;
If you have any questions or queries in relation to Public Sector AVC’s please fill in the form below. We would be more than happy to help.