In every conversation that I have with clients considering pensions, two questions are always asked:
- Should I start a pension now?
- How much should I invest?
My personal view on the first question is that it’s dependant on the individual’s personal and financial circumstances at that particular time. For example, if you are saving for a mortgage or about to start a family then these costs will be more important in the short-term, and perhaps putting off your pension may suit your financial needs best.
However, if you are in a position to invest surplus earnings/cash, then a pension will provide you with a tax-efficient savings plan for your retirement. This leads on to the second question, how much should I invest.
Pension investments are very tax-efficient when compared to a normal savings plan. The difference being that you get tax relief based on the top rate of income tax you pay. For example, a person paying income tax at 40% on their earnings will get tax relief of €40 for every €100 invested (or €20 where they are paying income tax at 20%). Therefore when considering how much to invest in a year you should ensure you realise the maximum tax efficiency from that contribution.
However, the amount of tax relief available on yearly pension contributions is capped based on the income and age of the pension contributor during that year.
Net Relevant Earnings (NRE) Net relevant earning are relevant earnings (Employment income, self-employed trading income) less losses, capital allowances and charges which are offset to reduce an individual’s taxable income in a tax year.
Rental profits or investment income such as deposit interest/dividends do not form part of relevant earnings, and as a result the tax on same can’t be reduced by pension contributions made.
Furthermore, in recent years the net relevant earnings figure assessable for tax relief has been capped at €115,000. For example, a 35 year old tax payer who earns €150,000 per annum will be capped at claiming tax relief on €23,000 pension contribution (€115,000*20%).
Where in any year an individual is restricted on the tax relief they can claim due to the above limits, this excess contribution amount can be carried forward to claim in future years.
Contributions by individuals to their private pension funds (incl. AVCs) before the 31st October (or later if filing on ROS) in a year can be used to claim tax relief on tax paid in the previous year. For example a top rate (40%) taxpayer who can invest a further €10,000 in a pension contribution before the 31st October 2021 (or ROS online -17th November 2021), can obtain an income tax refund of €4,000 from the 2020 tax year. This would result in a net cash out flow of €6,000 in October 2021.
In addition to the tax relief on personal pensions (PRSA, RAC), where an individual’s employer contributes to an employee’s pension under a company pension scheme, the individual is not subject to tax on the contributions made by the employer.
This results in no taxable benefit arising on the employee. One of the key benefits of the company pension scheme is that the employer contribution doesn’t reduce the employee’s own tax relief limit set out above. However employer contributions to company pension schemes must be within prescribed limits. This contrasts with employer contributions to a PRSA which are combined with the employee’s own PRSA contributions for calculating the employee’s maximum tax relief limit.
Under the company pension scheme an employer will usually set rates at which they will contribute to the employee’s pension fund. The employee will then make their own contributions to the fund based on a set percentage of their salary. Where an employee wishes to increase their own contributions to the fund, they can do so by making additional voluntary contributions (AVCs) to the fund. Again, the employee needs to be aware that such AVC payments should be within the above tax relief limits to ensure the most tax efficient contribution is made.
The majority of personal pension or PRSA holders should be entitled to take a maximum 25% lump sum from the fund on retirement. In the case of company pension scheme holders, they should in certain scenarios, be able to take 1.5 times their final salary as a lump sum.
Currently, the maximum lump sum an individual can take tax free is €200,000.This is a lifetime limit and therefore applies to all pension funds collectively regardless of whether the lump sums are taken at different times from different pension funds by the individual.
For individual’s whose lump sum exceeds €200,000, they can obtain the next €300,000 (€500K-€200K) at a tax rate of €20%.For lump sums exceeding €500,000 the excess is liable to tax at the individual’s marginal rate of tax.
The balance of your pension fund will be used to purchase an Annuity (income for life), an ARF/AMRF, or alternatively take as a taxable lump sum. Tax on yearly annuity payments, or ARF/AMRF withdrawals will then be liable to tax based on the individual’s annual income at that time.
Retiring Family Business Owners All too often, we treat our businesses like family, and like family we hope they will continue to grow and develop and be even more successful when we are no longer there. And it’s on this point where I find that pensions are a welcome distinction from business assets being transferred to the next generation.
Many business owners retiring often worry that the business they are about to depart from needs the businesses cash it has built up to continue or expand. This view point more often than not makes the owner feel somewhat guilty at the suggestion of withdrawing the businesses own cash reserves to assist them in retirement.
A pension fund however is never viewed by business owners as being part of the business assets, and for this reason alone it provides additional financial security to the retiring business owner who find themselves in such a predicament.
In a country with an ageing population, it is inevitable that at some stage in the future the state pension will come under greater pressure. These pressures may very well lead to reduced pension rates paid or increased pension ages for its citizens. Therefore anyone wishing to safeguard their own retirement, a private pension is certainly a tax relieving option to consider.