Employee contributions themselves are limited to an overall maximum percentage of gross pay, including any contributions required by the rules of the scheme. The maximum allowable employee contribution, originally 15% for all, is now age related: 15% for those under age 30; 20% between 30 and 39; 25% for those aged 40-49; 30% for those aged 50 or over; 35% for those aged 55 and over and 40% for those aged 60 and over.
Employer contributions are made in addition, as long as the overall benefit limits are not breached. An earnings 'cap' of €254,000 applies to contributions by employees. With effect from 7/12/2005, the maximum allowable pension fund which an individual can accumulate and which can avail of the tax reliefs afforded to pension funds is €5million.
Once contributions are received by the pension scheme trustees, they are invested through an insurance company or other investment manager. They are usually invested separately for each individual member, so that the member's share of the fund can be easily tracked.
Exactly how they are invested depends on a number of things, including how close the member may be to retirement age. For example, if the member was quite close to retirement, appropriate investment would be in assets whose value was not likely to reduce. A younger member might invest in more volatile assets, in the hope of making substantial capital gains before he needs to 'consolidate' in the run-up to retirement. The assets of pension funds build up without any tax being paid on investment income or capital gains. Under normal circumstances, therefore, they should accumulate faster than an investment fund that has to pay tax.
When you retire, the total fund accumulated in your name becomes available to the trustees to provide benefits. The maximum benefits that can be provided are dictated by the Revenue Commissioners' rules. For those retiring at normal pension date, having completed at least 20 years' service, the maximum lump sum is 1.5 times the salary, and the balance of the fund available for the individual has to be applied to purchase pensions (for the scheme member and also perhaps for his/her dependants). The amount of pension available after the lump sum has been taken will be dictated by (a) the value of the accumulated fund and (b) the state of annuity rates at the time of retirement. Neither of these can be predicted in advance. The best that can be done in the case of someone who is years away from retirement age is to make a reasonable estimate of what might be available. Such an estimate would be based on assumptions regarding future fund performance and annuity rates. It is important to review these regularly, to measure actual performance against the assumptions. That way, changes can be made to the rate of contribution if needed. The maximum lump sum which an individual can receive from a pension fund after 7/12/2005 is €1.25 million (from 2007) onwards, this figure will be adjusted in line with an earnings index).
If you die in service, the fund that has accumulated for your pension will form part of the overall death benefit provided by the scheme - how that is calculated will be determined by the rules of the scheme itself. Death benefits may be paid as tax-free lump sums within certain limits, with any balance going to purchase pensions.
That will depend on the choices you made at the point of retirement to provide for your dependants. Some people set up a pension only on their own lives. Others ensure that part of the capital available at retirement age is used to buy an extra pension which will be paid to a spouse or other dependant on the death of the member after retirement. The available capital can be used to tailor the benefits to fit your individual circumstances.
From the foregoing, it will be obvious that a defined contribution scheme places a great many things firmly under the control of the member. Benefits do not have to be taken in any prescribed pattern, even though the maximum levels of benefit are laid down by the Revenue Commissioners. Thus, the scheme member can decide on the distribution of benefits, between personal pension, lump sum, dependants' pensions and cost-of-living increases.
As well as this flexibility, defined contribution schemes have the great benefit of allowing an individual to trace the buildup of his fund, so that he knows its exact capital value as it accumulates up over the years. However, he will not be able to estimate with any accuracy how that fund will translate into a pension until he is quite close to retirement age.
If a person leaves service early, particularly at a young age, defined contribution schemes can generate leaving service benefits that are quite generous by reference to the relatively short period of service that the person has completed.
As against all this, there are risks involved. The member is taking the investment risk - i.e., the possibility that the returns on money invested could be poor - these cannot be guaranteed in advance in most circumstances. If poor investment returns are experienced, it follows that the capital available at retirement age would be less than a person might expect or wish for.
Secondly, there is the risk involved in annuity rates. The scheme member and the trustees are not stuck with the insurance company or investment manager with which the fund of money was built up - the money can be taken to the open annuity market to get the best value available in annuity rates. However, if long-term interest rates are low at the time of retirement, they will feed into all life offices' annuity rates and so the annual pension available for any given amount of capital is likely to be poor. That said, it does pay to "shop around" for the best quotations.