A pension: maybe you’ve got one and you have no idea what’s going on with it; it’s just that bit that comes out of your salary each month. Maybe you know you should set one up, but you don’t have the faintest notion of where to start (hint - a pension calculator is a good shout).

That’s fair – pensions aren’t the easiest thing in the world to master. But fortunately, you don’t have to be a finance expert to know how pensions work or what to do with yours. There are some technical terms involved in the world of pensions, but it’s all pretty straightforward once you know.

So, let’s dive in and see what it all means, shall we?

Different types of pension fund

If you’ve never given pensions much thought before, you might not know that there are a few different kinds of pension schemes. It’s important to know what kind of pension you have or plan to start so that you know what your retirement options are.

How does an employer pension or occupational pension work?

Essentially, this refers to a pension that you have via your employer. Typically, you will pay in an amount from your salary, and your employer will also make contributions. These are then invested with the aim of building a bigger fund over time, and you can then access the funds in retirement – or sooner, in some cases.

If you change jobs, you may be able to transfer your pension to a new employer pension or your own private pension.

Defined benefit vs defined contribution pensions

When it comes to employer pensions, there are two main kinds: defined benefit and defined contribution.

• Defined benefit schemes determine the amount you will receive in retirement based on your salary and your years of service. It is common in public sector employment, but not as typically seen in the private sector.
• Defined contribution pensions are more common and involve you paying a set amount (usually a percentage of your salary) into your pension, with employers often making a fixed contribution on top.

Read more about employer pensions here.

How does a private pension work in Ireland?

If you aren’t part of a pension scheme through your employer, then a private pension or personal pension is worth a look.

As the name suggests, this is a type of pension personal to you. It isn’t tied to your employer whatsoever, and you can tailor the pension to suit you. The most common types of personal pensions are a Personal Retirement Savings Account or a Self-Administered Pension.

PRSA (Personal Retirement Savings Account)

A PRSA is a private pension that is regulated and approved by Revenue and the Pensions Authority. They can be easily transferred, paused, and restarted, and you can increase and decrease your contributions at any time. These are common arrangements for workers not part of an employer pension scheme, such as self-employed workers and company directors.

Find out more about PRSAs here.

The state pension

The state pension in Ireland is available to all eligible residents aged 66 or older. It’s a weekly payment given to retired people, and as of January 2024 is up to €277.30 per week.

This works out to just over €14,400 per year – not exactly pocket change, but it won’t support most lifestyles either. That’s why it’s really important to start your own pension and try to increase the income you’ll have in retirement.

To be eligible for the state pension, you must have made enough PRSI (Pay Related Social Insurance) contributions before retirement age.

PRSI (Pay Related Social Insurance) contributions

PRSI is a flat tax of 4% on earnings. For the purposes of calculating social welfare (like the state pension) it is considered weekly. This means that one year of full-time employment is counted as 52 PRSI contributions, even if your pay is biweekly or monthly.

To be eligible to receive the state pension you must have started to pay PRSI before the age of 56, and have 520 PRSI contributions – in other words, you must have 10 years of work under your belt.

Income tax and pension contributions

You may well benefit from a combination of tax relief on the contributions you have made into your pension as well as a lower rate of tax on pension income in retirement, coupled with any growth on your pension investments being tax-free.

Income tax relief on pensions

One of the best reasons to make pension contributions is the income tax relief available on those contributions. If you are a 40% taxpayer, you could save €400 when you contribute €1,000 to a pension.

The amount of income tax relief you can claim depends on your age:

These contributions are capped at the first €115,000 of your annual income. Remember, even though you receive income tax relief on your pension contributions, you still need to pay Universal Social Charge (USC) and PRSI.

Income tax relief is not guaranteed. This relief on pension contributions is available to taxpayers with income taxable at either Schedule E or Schedule D (case I or II). In layman’s terms, this means that your income is Pay As You Earn (PAYE) employment or profit from a trade or profession. Most workers in Ireland fall into these categories.

On top of the income tax relief from pension contributions, any investment growth in a pension fund is tax-free.

AVCs (Additional Voluntary Contributions)

To maximise the income tax relief on your pensions and give yourself a better chance at a higher retirement income, you might consider AVCs.

Additional Voluntary Contributions are extra payments you make into your pension above and beyond the minimum required for your employer pension scheme. For example, if you’re 25 and pay 5% into a pension with an employer contribution of 6%, you might want to contribute an extra 4% to bring your total payment to the income tax relief threshold of 15%.

Click here to find out more about making the most of your pension contributions.

Paying tax on retirement income

Your pension (whether personal or employer) is subject to income tax and other charges. However, once you retire you can take a lump sum from your pension fund, some or all of which may be tax free. This will depend on your pension arrangement.

Some people will be able to withdraw up to 25% of the pension fund as a retirement lump sum, while others will have a lump sum based on salary and years of service. Generally you can receive up to a total of €200,000 tax-free on lump sums from all sources.

Pension withdrawals between €200,001 and €500,000 are taxable at the standard rate of income tax (20%) while anything over €500,000 is taxed under Pay As You Earn (PAYE) at 40% and is subject to Universal Social Charge (USC), applicable Pay-Related Social Insurance (PRSI), and any other taxes or government levies.

Still confused? Talk to an expert

Admittedly, pensions can be a lot to wrap your head around – even if you do have a handle on all the jargon. That’s where a financial advisor comes in.

Booking a call with an Irish Life Financial Services advisor is free, and there’s no obligation to buy anything after the call. It’s just a conversation about your finances, lifestyle, and goals.