How Pensions Work: Everything You Need to Know

By Rebecca Scaife

Published on: June 20, 2024

How Pensions Work: Everything You Need to Know

Most of us know we should make provisions for our old age well in advance. 

You’ve undoubtedly read in the media that state pension funding is under increasing pressure over the next decade and beyond due to our ageing population. There is currently no plan to raise the state pension age from 66, but for those of us still decades out from retirement, nothing can be confidently predicted or relied upon.

The state pension (highest level) is currently €14,400 per annum, which will just about cover the staples for most people – food, heating, and other basic necessities. 

As I hope to have more time to indulge my pastimes when I retire, I know I will need extra funds and the state pension to cover my hobbies and interests. People often tell us things like, “I’ll be old, I won’t need much money,” which is false, or “I will think about this properly when the kids have grown up,” which they often don’t.

Most people will, in fact, want and need to supplement the state pension with further income in their retirement so that they can travel, indulge their grandkids, run a car, dine out, contribute to charities, or pay for entertainment. 

For most people, this supplementary income usually comes from a private or occupational pension scheme. As we’ll see later, this option generally makes the most financial sense and gives some peace of mind when planning for one’s old age. 

So, what exactly is a pension? And how do pensions work in Ireland?

How Pensions Work in Ireland

A couple cuddling outdoors whilst sipping on hot drinks

A pension is a long-term savings plan designed to build up funds for your retirement.  

As we’ll discuss later, several types of pension structures are available in Ireland. Some pensions are linked to your employment and allow contributions to be made by both you and your employer. 

The contributions that are paid into the pension are generally eligible for tax relief at your ‘marginal’ or highest tax rate. There is no income tax relief except for PRSI and USC.

The rate of tax relief you receive is based on your age (see below), and the maximum amount of earnings that you can receive tax relief on is €115,000 per annum. These limits consider only your contributions; employer contributions are considered separately.   

AgePercentage Limit
Under 3015%
30-3920%
40-4925%
50-5430%
55-5935%
60 or over40%

In most cases, people pay pension contributions monthly via their payroll. This is the most straightforward way of receiving tax relief on our contributions. Your employer must facilitate this, even if they don’t offer a pension scheme or make any employer pension contributions for you. 

If your employer makes pension contributions, the amount is usually set at a set percentage, with employers matching the employee’s contributions. This is generally around 5% of employees matched by 5% of employees. If your employer offers matched contributions, you should take them; otherwise, you’re not receiving your maximum benefits from your job. 

Close to retirement but at a loss about your retirement options?

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What are AVCs?

Just because your employer only matches up to a certain %, doesn’t mean that you can’t pay more than this into your pension, up to the limits for your age stated above. 

These are known as additional voluntary contributions (AVCs). You may decide to make AVCs every month, which your employer can process through payroll. You may also wish to contribute a lump sum AVC or, on an ad hoc basis, claim the tax relief back at the end of the year. 

Lump sum AVCs to pensions are a particularly useful option if you have excess disposable income during the year. 

Certain pensions allow ad hoc payments without the regular monthly contributions. Self-employed individuals can reduce their tax liability each year by making a lump sum contribution to their pension when filing their tax return.

What Happens to My Contributions?

Unlike a savings account in the bank, when you contribute to a pension, your money is invested in various assets, such as equities (stocks) and bonds. The rate of returns your money receives depends on the mix of assets that your pension is invested in, the amount of ‘risk’ you take, and how the market performs over time. 

As a general rule of thumb, the further away from retirement age you are, the more risk you should take with your investments. Market volatility will even out over time, helping your fund grow faster. 

As you get closer to retirement, most people will choose to reduce the risk level of their investments. While the returns will be less, this is a way to safeguard funds that you will need shortly and won’t have time to rebuild if you take too much risk. From as much as a decade before your retirement date, you should work with your financial advisor to carefully consider how your funds are invested and ensure your investment approach aligns with your retirement intentions.    

It’s also worth noting here that the frequency of contributions can also reduce the impact of market volatility. When paying into a pension at regular intervals, for example, monthly, you aren’t trying to time the market. Rises and falls will increase quickly over time if you contribute regularly to a pension. 

How Compound Interest Applies To Your Pension

Your pension investments generate returns, which are then reinvested to earn more returns. The returns and growth in the pension are not subject to tax; more on that below. Over time, this cycle of earning and reinvesting (compounding) can lead to substantial growth in your pension pot.

For example, if you contribute €5,000 annually to your pension and receive an average annual return of 5%, you’ll earn €250 in interest after the first year.

For example, if you contribute €5,000 annually to your pension and earn an average annual return of 5%, after the first year, you’ll earn €250 in investment growth.

This investment growth is invested back into the pension, making your total investment for year two €5,250 (plus the contributions for year two). In the second year, you earn interest not just on your original €5,000 but on the €5,250, resulting in €262.50 in interest for that year.

This compounding effect continues, significantly increasing your savings over the long term.

When should I start paying into a pension?

A man looking at a piece of paper contemplating his future

Quite simply, you should start contributing as soon as you’re able. Even if it’s only a small amount to begin with.

The key to maximising the benefits of compound interest is time. The longer your money is invested, the more pronounced the effects of compounding. This is why you will often hear people saying that you need to start paying into a pension as early as possible. However, as we’ve discussed previously, this isn’t always possible for everyone or the best financial advice. 

If your employer is making contributions to your pension, then it certainly makes sense to join the scheme as soon as possible if you can afford to. 

For example:

A 26-year-old starts paying €250 into her monthly pension (€125 employee and €125 employer). She never increases her monthly contributions, and after 40 years, when she reaches retirement age, she has €383,094.64 in her pension fund. This is comprised of €120,000 in contributions (€60,000 for her and €60,000 from her employer) and €263,094.64 in investment growth.

A person who starts paying into their first pension at 46 and pays €500 per month will have accumulated the same amount in contributions (€120,000) by retirement age 66. However, as they have only saved and accumulated interest over half the time (assuming the same interest rate for both is a stable 5%), the interest accrued will be significantly less at €86,373,15.

Taxation of Pensions

The returns and growth within a pension are not subject to tax. 

Other types of non-retirement savings and investments are subject to taxes such as Exit Tax, Capital Gains Tax (CGT), Income Tax, or DIRT. Under ‘deemed disposal’ rules, investors must pay tax every eight years on certain exchange-traded funds (ETFs) and funds, even if they haven’t cashed them in yet.  

When it comes to retiring the pension, you can take 25% (up to €200,000) out as a tax-free lump sum.

Above this, amounts between €200,001 and €500,000 are taxable at only the standard tax rate (20%). €2 million* is the ceiling or total value of tax-relieved pension benefits that an individual can draw from. *In some cases, a defined contribution pension of up to €2.15 million can be beneficial and should be discussed with your advisors.

To illustrate the above, let’s look at our 26-year-old pension saver again.

As she has paid her contributions from her gross salary, she has received tax relief at source. If she had paid her €125 contributions from her net salary, they would have cost her €175 monthly.

Instead, they have reduced her monthly take-home pay by €75, and the €60,000 in contributions has only cost her €36,000.

Depending on how she chose to invest the funds outside of a pension account, the interest could have been taxed anywhere between 33-52%, significantly eroding the final value. 

How much will I receive from my pension per year?

Looking at the example of the 26-year-old pension saver above. They will have a pension fund of €383,094 at retirement. This would equate to:

  • A 25% tax-free lump sum of €95,774 at retirement.

  • An annual income of €16,000 per annum (from an annuity with circa 5% rate)

Assuming they are eligible for the full contributory state pension, they will also receive €14,400 annually. This would give a total income of circa €30,000 per annum or €2,500 per month.

How to set up a pension

The first step you should take if you want to start a pension is to speak to your HR or payroll department. If your employer offers pension contributions as part of your remuneration, you will usually be required to join the company pension scheme. 

Anyone who is self-employed or works for a company that doesn’t contribute usually engages a financial advisor to set up a pension plan. 

A new auto-enrolment retirement savings scheme will commence in January 2025 for certain private sector workers who are not paying into a pension. Much of the details have yet to be announced, but we will post an update as information becomes available. 

Other sources of income in old age

Pensions really make the most sense for retirement planning due to the generous tax allowances when paying into and maturing a pension. 

Savings and investing from post-tax income will simply cost you more money.

For every €200 you earn gross, after income tax (40%), PRSI (4%) and USC (circa 6%) are accounted for, your net income is €100 to invest. Gains on this €100 will also be subject to taxes.

In contrast, €166 into your pension will only cost you €100 from your net pay.

Property as a retirement investment is an extremely popular option in Ireland.

While some people have had great success with property investments, many potential downsides exist. We believe the risks and drawbacks make the property an unwise choice for retirement planning. 

Many individuals build their businesses over several decades to provide them with a nest egg for retirement.

While several tax relief schemes exist to assist with selling or retiring from a business, this can be a risky strategy. Finding both a buyer to buy your business and a manager to run it is quite a difficult task.

In our experience, businesses are also typically overvalued by their owners. Funding a pension through the company should always be considered.

We often speak to people who are waiting for an inheritance to fund their retirement. This plan has several flaws.

Individual longevity is often underestimated, and potential care costs are rarely accounted for.

The Fair Deal scheme is still in existence now, but if it is abolished in the future, an inheritance could be watered down very quickly. In summary, relying on an inheritance in any circumstances is a risky business.

We always recommend funding a pension to the maximum before considering alternative retirement planning methods.

Close to retirement but at a loss about your retirement options?

Download our guide NOW to learn how to get the best out of your retirement funds.We reveal:
  • How you can shore up your personal security by investing wisely,
  • Why you could lose out BIG if your money is not in the right place,
  • Ways to turn your success into MASSIVE wealth so you can lie back and relish your retirement.
Don’t miss out! Future-proof your finances RIGHT NOW – Download our Approaching Retirement Guide.

Who regulates pensions in Ireland? 

Great question. We’re sure you want to know that your pension is safe.

The Central Bank of Ireland regulates pension providers, including insurance companies, investment firms, and financial institutions that offer pension products. This regulatory body supervises financial services firms to maintain financial system stability, ensure integrity, and protect consumers.

To operate within the Irish market, pension providers must secure authorization from the Central Bank and meet various regulatory requirements.

Ireland’s occupational pension schemes and funds are also regulated by the Pensions Authority, an independent statutory body established by the Pensions Act of 1990.

The Pensions Authority oversees the administration of pension schemes, including fund management, ensuring they comply with legal mandates and safeguarding the interests of pension scheme members.

Pension funds are required to follow stringent regulatory standards related to investment practices, reporting, and governance.

Types of Pensions Explained

Changes in legislation and several attempts at simplifying and improving the pension landscape over the last few decades have made various types of pension vehicles available in the Irish market.

Defined Benefit Pension: A DB scheme provides a set annual income to the retiree at retirement. The amount depends on years of service and final salary. 

Occupational Pensions/Defined Contribution Pensions: These are linked to your employment with the contributions fixed by the scheme’s rules. The employer and employee contributions are invested with final benefits payable determined by the fund available at retirement. 

Personal Pensions: A personal pension is not linked to a company and is, therefore, used by self-employed individuals or those who do not have access to an employer pension scheme.  

Personal Retirement Savings Accounts (PRSA) – PRSAs are the most flexible type of pension available. They can be linked to your employer or held as an individual. You can move your PRSA from one employer to another or use a PRSA when self-employed. Due to a lift in restrictions on maximum funding levels by employers, PRSAs are currently very appealing to company owners and Directors.  

Buy-out Bonds (BOBs)/Personal Retirement Bonds (PRBs) – buy-out bonds allow individuals to move their pension benefits out of employer occupational schemes and into an account in their own name. This gives the person more control over the pension and its investment. One major advantage to BOBs is that many will allow the owner to retire the benefits when they turn 50.

It is possible to hold multiple or combinations of the above types of pensions by the time you retire if you have had various jobs or occupations over your career. 

However, you can only fund one pension at a time from each of your income sources. 

It’s important to keep good records of all your pension policies. Retiring pension policies separately and at different times and stages may be possible. However, you must declare the information relating to all of your retirement benefits each time and the various accounts combined in calculating your standard fund threshold. 

How much am I charged for my pension?

Pension policy fees vary widely and wildly in Ireland. Generally, your fees are a combination of various elements:

Policy fee: €0- €7.50 per month can be common per policy.

The employer, Employee, and AVC parts of a pension are often allocated different policy numbers and, therefore, charged separately.

  • Broker/advisor fee: 0.25-1% per annum
  • Annual Management Charge/Pension Provider Fee: 0.4% to 1%
  • Investment or fund management fee: 0.25-2% of fund value
  • Bid/Offer Spread: 0%-5% range
  • Allocation Rate: typically 95% to 100%
  • Minimum Annual Fee: Some providers commonly use €500 to €1,000.

Providers can often update their terms & conditions with little notice. They are not required to seek agreement or acknowledgement from the policyholder in response to any fee increases. Take this as a warning to ask for a full breakdown of costs from your advisor and monitor it annually.

Fees for occupational schemes tend to be lower as they are split among multiple members, or the employer pays a flat fee to the scheme’s administrators. 

When do I get my private pension/state pension?

An older couple dancing in their kitchen

The state pension is currently payable in Ireland once you turn 66 (but you can now defer to age 70). Whether you are eligible for a contributory or non-contributary state pension will depend on your employment history and the number of PRSI contributions you have made. You can check your contribution history on MyWelfare

The age at which you can access your private pension benefits will vary depending on the type of policy. As stated above, BOBs can often be retired from age 50, and in some instances, it may be prudent to retire these benefits early to pay off debt

The rules usually set a defined benefit or occupational scheme’s retirement date, starting at age 65.  

The retirement age can be brought forward in certain circumstances (due to ill health or disability). However, extending the normal retirement age (NRA) to later if you choose to keep working or don’t require the benefits immediately is generally possible. 

What happens after I retire my pension? 

Once you have reached retirement age and decide to take your pension benefits, you can take up to a 25% tax-free (or tax-reduced) lump sum. 

The remaining funds can be left in a Vested PRSA, invested into an Approved Retirement Fund (ARF) or used to purchase an annuity. 

When choosing which route to take, various things must be considered. The most important thing is ensuring you have enough money to live on well into your old age.

Most people vastly underestimate how long they will live and how much money they will need in retirement. Your circumstances and strategies to ensure that your pension fund lasts through retirement should be discussed well before retirement with your Financial Advisor. 

Can pensions be inherited?

In short, yes, they can. However, how much is inherited depends on several factors.

Pre-Retirement Pension Fund

The pension fund is paid to the surviving spouse/civil partner as a tax-free cash lump sum in the event of death or into the estate. Children or other beneficiaries may be liable to pay inheritance tax, depending on thresholds and the value of the pension fund. Unmarried couples should be aware of cohabitation laws and the rights of cohabiting couples, see here

Post Retirement Pension

A spouse or civil partner will inherit the pension tax-free but is liable to income tax on withdrawals. For those who hold a post-retirement annuity, the rules can vary depending on your circumstances and wishes. These term and conditions will have been discussed and decided with your financial advisor when you enacted the policy.

An approved retirement fund (ARF) goes to your estate and is generally inherited by the surviving spouse. It is important to know that probate can take a significant amount of time, during which the inheriting spouse cannot access the funds.

If one ARF is the sole income for a retired couple, then it’s important to consider withdrawing emergency funds from the ARF and holding them separately for the surviving spouse to live off while they wait for the estate to be settled.

Wrapping Up

Understanding pensions in Ireland is key to a comfortable and financially secure retirement. The state pension only covers the basics, so you must consider additional income from private or occupational pensions. You can boost your retirement savings by managing your pension proactively, taking tax relief, and making informed decisions on contributions and investments.

At Everlake, we help individuals navigate the complexities of pension planning. Our advisors can provide personal advice tailored to your needs and goals.Whether you’re just starting out on your pension journey or need a review of your current plan, we’re here to help.

Don’t put it off.

Contact us now to book an appointment with one of our pension planners. We’ll help you build a solid and tax-efficient retirement plan for your peace of mind.