How Tax Efficient are AVCs?

I joined the Trusted Advisor Group recently and came across this article on their website.

It was written by Tony Gilhawley FSAI, Technical Guidance Ltd.

Additional Voluntary Contributions (AVCs) are a way of topping up your employer pension scheme benefits, at your own expense with the benefit of tax relief. But how tax efficient are AVCs?


If you pay an AVC of €1,000 and get income tax relief at 40%, your net outlay is €600. What you get back at retirement will depend on a lot of factors, including how your take your AVC benefits and how they are taxed.

Let’s assume investment returns and charges cancel each other out, so at retirement your €1,000 AVC fund is always available to provide benefits.

The best outcome is where you can take the AVC fund fully as a tax free lump sum; for example, where you are in a DB scheme or in a DC scheme taking benefits under the traditional benefit option and the normal scheme lump sum is within the Revenue maximum approvable lump sum.

So in this example, we assume you pay in a net €600 and get back a €1,000 at retirement. The rate of return provided varies by how long to retirement before you get the €1,000 back:

AVC fund taken fully as a tax free lump sum

Years to retirement AVC Annual rate of return
1 66.7%
2 29.1%
3 18.6%
4 13.6%
5 10.8%
10 5.2%
15 3.5%
20 2.6%

The AVC tax relief provides a double digit return, where you pay the AVC within 5 years of retirement. It’s a whopping 66.7% pa if you get the €1,000 back after one year. You can see why ‘last minute’ AVCs used to provide additional tax free lump sum are so popular, particularly in the public service.

A common scenario is where the AVC fund will be taken under the ARF option, i.e. 25% as a tax free lump sum, with the balance transferred to an AMRF/ARF from which withdrawals will be subject to higher rate income tax and USC at, say, 5%.

The net value of the €1,000 AVC fund at retirement in this case will be €250 + €750 * (1- 45%) = €662.50 in return for a net outlay of €600. The annual return provided by the AVC tax relief is still positive but at a much lower level than where the full AVC fund could be taken fully as a tax free lump sum:

AVC fund taken 25% tax free, 75% taxed @ 45%

Years to retirement AVC Annual rate of return
1 10.4%
2 5.1%
3 3.4%
4 2.5%
5 2.0%
10 1.0%
15 0.7%
20 0.5%

Over 5 years the return provided by the tax relief is just 2.0% pa, compared with 10.8% pa if the fund could be taken fully as a tax free lump sum.

Of course there are many other scenarios giving different outcomes, e.g. where the tax free lump sum part is more than 25%, where the taxable benefits may be taxed at standard rate rather than at higher rate, etc.  The projected return provided by the AVC in these scenarios may be lower or higher than the return above.

AVCs generally make tax sense, but the return provided by the tax relief varies a lot, depending on how the AVC benefits will be taken and taxed at retirement.

If you want to discuss AVCs to topup your Employer Pension Benefits give John a call on 087-6534444

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