PRSAs can give better choice once the pension saver decides to retire, writes Laura Slattery.

Additional voluntary contributions (AVCs) are likely to be on the radar of company pension scheme members, especially older workers, who believe they should be doing everything they can to build up their retirement income.

So why should scheme members be topping up their pension fund with AVCs?

Isn't seeing a significant chunk of their salary disappear into the company pension fund enough to guarantee a decent replacement income for when they're no longer working?

The answer is that it depends on the scheme. The maximum pension benefit that can be derived from an occupational scheme is two-thirds of a person's final salary, with some features such as index-linking and spouses' pensions also permitted.

But few people ever achieve this level of pension through their main scheme. Most will have a retirement income that falls far short of both the maximum funding rules and their own expectations.

For a member of a traditional defined benefit pension scheme to maximise their retirement income, the terms of their scheme would have to be set up in a way that would give them 1/60th of their final salary for each year of service.

They would then have to have unbroken service of 40 years to receive two-thirds (40/60ths) of their salary as a pension.

"In practice, it hardly ever happens," says Mr Pat Ryan, pensions manager at Canada Life.

Many schemes are based on 1/80th of salary, while some workers take career breaks, hop from job to job or do not find pensionable employment until their late 20s or early 30s.

"AVCs are a way to bridge the gap," says Mr Ryan.

The main advantage of diverting surplus cash into an AVC scheme rather than any other savings or investment scheme is the tax relief available.

For people paying tax at the higher rate of 42 per cent, plus PRSI and the health levy at 6 per cent, an AVC contribution of €100 effectively only costs them a net €52.

The same is true of any pension contribution up to a certain percentage of a person's net earnings, with the ceiling increasing as the person gets older (see table).

The terms of the main company scheme, however, may only require a contribution of, say, 5 per cent, leaving plenty of scope for people to avail of tax relief on pensions by making AVCs.

With the relief allowed increasing as people get older, those aged 50-plus can contribute up to 30 per cent of their net earnings to a pension.

It is when they reach their fiftysomethings that workers are most likely to start checking out the state of their pension provision.

"That's when time is running out," says Mr Ryan.

It is also the time when people are more likely to be "empty-nesters" with grown-up, self-sufficient children and a mortgage that has been whittled down to the final few payments. They may have more cash to spare.

Up to now, those occupational scheme members who did want to make AVCs were obliged to use the vehicle nominated by the trustees of their main pension scheme.

But following the Revenue Commissioners' approval of a new type of standalone AVC vehicle, employees now have a choice: they can either use the company selected by their scheme trustees or a separate Personal Retirement Savings Account (PRSA).

Two insurance companies, Canada Life and Eagle Star, have already started to promote these new standalone AVC PRSAs.

Up to now, employees who were already a member of an occupational pension scheme have had no incentive to get into PRSAs, which were designed to make saving for retirement simpler and more flexible.

It has been possible before now to place AVCs in a PRSA, but to qualify for tax relief on the contributions, employees had to get permission from the trustees of their employer's main scheme, who would then need to change the rules of the scheme.

In practice, this was a non-runner, Mr Ryan says.

Now the insurance companies selling AVC PRSAs will take responsibility for notifying the trustees that the scheme member is contributing to a standalone PRSA.

"But we don't say how much and we don't say what fund your investing in," says Mr Ryan. "That's totally your business."

The provider will also carry out a funding test to make sure that future benefits derived from the AVCs will not push the pension scheme member past the Revenue's overfunding or tax relief limits.

According to Mr Ryan, the new system means employees can, like the self-employed, take control of the investment decisions that will affect their wealth later on.

One advantage of PRSAs is that they give better choice once the diligent pension saver reaches the point when they decide to retire.

PRSAs allow people to invest their cash into an Approved Retirement Fund (ARF). In an ARF, people can carry on investing the bulk of their pension fund throughout their retirement rather than converting it into a monthly cheque when they retire.

Crucially, the money can be passed on to family members as part of their estate.

"The effect of the new rules might be to succeed in making PRSAs trendy," says Mr Ryan.

Permanent employees included in an employer-sponsored pension scheme have learnt to value pension scheme membership and are committed to accumulating job replacement income for when they retire, he says.

They are also more likely to pay tax at the higher rate of 42 per cent, he adds, so the tax relief will be of more value than it is for a person who only pays tax at 20 per cent.

The new rules also mean the October 31st tax deadline will be relevant to more PAYE employees, as it is by this date that people can backdate their pension contributions for the previous tax year.

The other way of getting tax relief is by having your tax credits adjusted.

Employees convinced of the merits of AVCs but unsure whether to stick with their trustees' choice or an AVC-PRSA should probably check out which one is most competitive on charges. The AVC PRSA providers argue that their vehicles are more discreet.

"The PRSA is a contract between the provider and the individual, which is important if the employee is concerned about confidentiality," says Mr David O'Dowd, product development manager at Eagle Star.

"The employer isn't necessarily included in it and they won't know how much you're putting aside," he says.

Eagle Star is promoting long-term saving by AVC PRSAs as a smarter way of putting money aside than typical savings plans, such as Personal Investment Plans (PIPs).

The insurer gives the example of a person who has €100 to invest each month out of their take-home pay. The person pays tax at 42 per cent and PRSI at 6 per cent.

A PRSA investment of €192.31 is made each month, which has a net monthly cost of €100.

Based on a 15-year term, a gross investment return of 6 per cent and contribution increases of 3 per cent, the PRSA would achieve at least a 20 per cent higher return than a PIP with typical charges, Eagle Star says.

If all the proceeds of the PRSA can be taken as part of the tax-free lump sum on retirement, the PRSA will give the person a benefit of €58,400, compared to €27,300 under the PIP - a difference of 114 per cent.