An Occupational Pension which is more commonly known as a Company Pension is setup under a Trust by an employer (company or individual) to provide retirement and/or death benefits for employees (including Directors) and has to be exempt approved by the Revenue. Company Pension arrangements can include any number of members from one upwards.
State pensions are not ignored in the design of Company Pensions and are generally taken into account when calculating the total pension paid. In most schemes, the State pension payable to an employee is deducted in whole or in part.
There are two basic types of occupational schemes are defined benefit and defined contribution.
Defined benefit schemes are also called 'final salary schemes.' Employees or their dependants are paid a pension in accordance with rules generally based on salary at the time of retirement or an average of the last years, together with the number of years service.
The rate of the employee's contribution is also defined. In contrast, the final cost to the employer is not defined. Future salaries, investment returns and life expectancy have a direct impact on costs.
An actuary is responsible for estimating the contribution rate required to secure the benefit promise. The law stipulates that a valuation of the fund is done at maximum intervals of 31/2 years. Solvency standards have to also be reviewed by the actuary.
The funding of defined benefit schemes is normally done on a group basis as there is no individual amount attributed to each member.
The existing trend of an irreversible move away from defined benefit, is accelerating. By guaranteeing employees a pension related to salary on or near the retirement date, employers take the risk of under funding. People are living longer, investment returns are lower and the new accounting standard called FRS 17 which is likely to come into full force soon, will require that a pension fund surplus or deficit be reflected in a company's balance sheet.
Employers contribute an average of 15% of salary in 'final salary schemes' compared with 6% of salary, for 'money purchase schemes'.
Defined contribution schemes are also known as 'money purchase schemes'. The employee's benefit is determined solely by reference to the scheme contributions by the employer and where contributory, by the individual, and the investment returns earned on those contributions.
Both the rate of the employer's and member's contributions are fixed. The payout is not guaranteed and is dependent on the return achieved from the funds where contributions are invested. Nothing else is guaranteed and the outcome for each member will depend upon the return achieved on his fund of money and the investment conditions prevailing when it becomes necessary to convert the fund into a pension on retirement. In periods of long bull markets, these schemes can be very rewarding and conversely when there is a sustained downturn. The employee can have the flexibility of choosing how the fund is used at the time of retirement.
In these schemes, the contributions being made by and for each member are individually tracked. An employee can know at any time what share of the pension fund he/she has. An employee who is given details of this entitlement under a defined contribution scheme will receive a notice of value but estimates of future value are not allowed.
Finance Act, 2002 - Changes to Company Pension Rules including AVC's
The Finance Act, 2002 provides for a significant improvement in the taxation relief for members of occupational pension schemes.
Changes in pension rules for employees
In order to encourage employees to increase their level of pension cover, the following changes have been made:
(1) The previous limit of 15% of qualifying annual earnings for tax relief for contributions, including Additional Voluntary Contributions (AVCs) by employees into occupational pension schemes has been increased to the tax relieved limits that applied to contributions by those not in occupational pension schemes, to Retirement Annuity Contracts (RACs). These limits are:
Up to 30 years of
age 15% of net relevant
30 up to 40 years of age 20% of net
40 up to 50 years of age 25% of net
30% of net relevant earnings
(2) Where a self-employed person who is in a RAC scheme joins an occupational pension scheme, he/she will no longer be obliged to terminate his/her RAC scheme but can continue contributing to the RAC or take out a further RAC but without any tax relief in respect of these continuing or further contributions and without notifying the employer as is required for an AVC.
(3) The previos rules provided that under an occupational pension scheme, the maximum benefit that can be provided for a spouse or dependant is two thirds of the full pension the pension scheme member could have obtained and the maximum for all dependants together is 100%. The new tax relief rules allow pension schemes to provide benefits, if they wish, up to 100% of the member’s possible pension on retirement to an individual spouse/dependant.In addition, tax relief is provided for the new Personal Retirement Savings Accounts (PRSAs) where they are used as an AVC in line with the change at (1) above. This means that where a PRSA holder joins an occupational pension scheme and takes out an AVC - PRSA, the annual limits on such AVC-PRSA contributions for tax purposes will no longer be limited to 15% but will be increased to 30% through age progression as at (1) above.
Taxation of Pensions' Rules
Pension schemes are subject to approval by the Revenue and are termed 'exempt approved'. They have the following tax advantages:
Contributions by employers and employees are fully allowed for tax relief. The maximum employee contribution on which tax relief can be claimed ias per the earning limits above.
Employer contributions are not treated as taxable income as far as employees are concerned. The employer must fund at least 1/6th of the cost of the pension benefits.
The investments of pension funds are allowed to accumulate without paying tax on their income and capital gains.
Benefits are subject to PAYE with the exception of the limited amounts which can be paid on retirement or death, as lump sums, free of tax. PRSI is payable at a reduced rate.
The employee may take a tax-free lump sum of 1.5 times final remuneration (subject to a minimum of 20 years’ service).The maximum pension that may be paid is 2/3rds of final remuneration (subject to a minimum of 10 years’ service). However, this amount may be reduced if the employee takes the tax-free lump sum.In the Budget 2002, the Minister for Finance announced a reduction in the tax on the refund of an employee's pension contributions from 25% to 20%. The right of a refund only relates to pre-1991 pensionable service and from Jan 1st 2002, employees with under 2 years service.