Defined Contribution Pension Schemes are a type of Occupational pension scheme. Under a defined contribution scheme, you and your employer together contribute to build up a Retirement Account for you. This Retirement Account should grow over the course of your working life through investment growth and ongoing contributions. When you retire, you can use the Retirement Account to provide you with retirement benefits, such as a Retirement Lump Sum, an income for life in retirement (annuity) and/or an Approved Retirement Fund (ARF).
Use the links below for further information on defined contribution pension schemes:
What level of retirement benefit will you receive?
Under a defined contribution scheme you are not guaranteed any specific level of retirement benefit. Factors that will influence the level of benefit that you will receive are likely to include the following:
- The length of time for which contributions are made
- The level of your contributions
- The level of your employer’s contributions
- Investment performance
- The level of annuity rates when you retire
How long should I make contributions for?
The longer you and your employer make pension contributions, the larger your Retirement Account is likely to be. If €5,000 a year is contributed to your Retirement Account for 20 years and investment growth averages 6% per annum, at the end of the 20 years you would have a Retirement Account worth €183,928. If contributions are made over a longer period of 30 years, with the same growth rate, the Retirement Account would be more than twice as large at the end of the period at €395,291.
What will determine your employer’s level of contribution?
The terms of your pension scheme will determine the level of your employer’s contributions. Typically an employer providing an occupational pension scheme will contribute a set percentage – such as 5% or 10% - of an employee’s salary to his or her Retirement Account.
What will determine your level of contribution?
Again, the terms of the scheme will dictate the minimum percentage of salary that you must contribute to be a scheme member. Your contributions will benefit from tax relief at source. Depending on your level of income, a contribution of €100 to a pension may only reduce your after tax income by €60 due to the effects of tax relief.
Can you increase your level of contribution beyond the minimum?
Yes, you can increase your level of contribution by making Additional Voluntary Contributions (AVCs). AVCs are, as the name suggests, voluntary contributions that you make to your Retirement Account from your salary. AVCs also benefit from income tax relief at source, so they are a very tax efficient way of saving money. The limits of what you can contribute as AVCs are determined essentially by your age and income.
How should you invest your Retirement Account?
Your scheme will have a default fund, and if you make no investment choices your contributions will be placed in that default fund. It is likely that your scheme will have other fund options besides the default. Those fund options will have different risk profiles.
Generally speaking, the higher risk a fund, the more growth that can be expected from it over the very long term. However high risk funds are also volatile, and will experience many ups and downs over the years. Low risk funds will be much less volatile, but will also probably deliver much lower growth, on average, over the very long term.
It is generally considered appropriate to invest on a medium or perhaps even a high risk basis when your retirement is distant. After all, even if the fund falls in value, this means that your new contributions buy in at a cheaper price, so a fall in value can actually be good news when your retirement is a long time away. However when retirement is closer it is usually sensible to reduce risk.
Your default fund may have a facility, known as “Lifestyling”, which will automatically reduce your exposure to risk as you approach retirement age.
What level of investment performance is it reasonable to expect?
If you invest in a low risk cash fund, returns are likely to be no higher (and may be lower than) short term deposit interest rates. If you invest in a high risk equity fund, it may be reasonable to expect average returns over the very long term of 3-5% ahead of inflation. In other words, if inflation averages 2% per annum, then the average expected return on a high risk equity fund would be in the range 5-7%.
However higher risk funds will experience years of much worse and much better returns than this broad average would suggest.
You may want to find out more about the principles behind saving and investing. These principles are, in general, similar within a pension fund to outside of one.
What are annuity rates and why are they relevant?
An annuity is an income for life. Annuity rates are the rates at which life assurance companies will sell you an annuity.
At retirement, if you use your pension to buy an annuity, the level of income that you receive will be determined by the following two factors:
- The size of the Retirement Account that you have accumulated
- The level of annuity rates at the time
What happens if I leave employment before retirement?
If you have less than two years of pensionable service, you may receive a refund of your contributions. However, if you have more than two years of service and do nothing, your pension should remain where it is, invested as you left it. The Retirement Account will be available for you at your scheme’s retirement age (or earlier if you take early retirement) and you can exercise your retirement options at that time.
Other options when you leave service include the following:
- Transferring your benefits to a new occupational pension scheme with another employer
- Transferring your benefits to a personal retirement bond (a policy with a life assurance company)
- If you have under fifteen years service, you can transfer your benefits to a PRSA
- If you are over the age of 50, you may be able to take early retirement
What will your options be at retirement?
Generally speaking you may be able to:
- Take part of your Retirement Account as a Retirement Lump Sum
- Purchase an annuity
- Take part of your pension as taxable cash
- Purchase an Approved Retirement Fund (ARF) or Approved Minimum Retirement Fund (AMRF)
Your precise retirement options will depend on factors such as your years of service, the size of your Retirement Account, whether you have made Additional Voluntary Contributions and whether you have other pension benefits. For further information contact Mercer.