Kieran Coughlan: New tax could take 40% of your pension fund

The Finance Bill is set to change the pension landscape drastically, over the coming months.
Kieran Coughlan: New tax could take 40% of your pension fund

The changes affect those with PRSAs and RACs — or, to give them their full titles, Personal Retirement Savings Accounts, and Retirement Annuity Contracts.

More particularly, those approaching or over 75 years old with such funds, will be affected.

These changes will affect the self-employed — including farmers — perhaps more than any other cohort of workers, because employees are generally covered by occupational or company pension schemes.

For the self-employed, PRSAs and RACs have proved to be flexible tools, allowing persons to make contributions as and how they see fit (with self-employed persons also being able to make retrospective contributions after the end of the tax year, but before the filing deadline.

Regular monthly contributions could be made, or once-off premiums could be paid.

All of the main pension providers offered such products, and with relatively competitive fees and charges, and a simple approach to administration, it was an attractive and easily understood option for tax payers and providers alike.

All told, both of these pension products proved hugely popular.

The imminent rule changes are set to restrict how a person can manage their pension pot from the age of 75 onwards.

Under the previous regime, a person who holds a PRSA and decided not to draw down benefits, could leave their fund preserved and transfer the fund to their successors under the terms of their will.

In contrast, a person who had activated their pension fund, converting it into an Approved Retirement Fund (ARF), would have two disadvantages.

Firstly, the person would be required to draw down at least 4% to 6% of their fund per year as income, or pay tax on a deemed distribution of that amount.

Secondly when the holder of an ARF dies, and the remaining value of their pension fund is transferred, to an adult child of the deceased, for example, the remaining fund value was taxable at a set rate of 30% income tax, without the benefit of any inheritance tax exemptions.

From a financial planning perspective, it made sense for the holders of PRSAs and RACs who could afford not to dip into their pension funds to leave these funds preserved and pass them on to their children, with the double benefit of no imputed income along the way, and the benefit of inheritance tax thresholds.

From a practical perspective though, many farmers would not have activated their funds prior to age 75 for a number of genuine reasons; many farmers continue working well past the “normal” retirement age, and accessing pension funds while still working didn’t make a lot of sense, particularly where a tax payer is already paying tax at the high rate.

Secondly many pension funds are relatively modest, and farmers sought to leave their fund intact for as long as possible, in order that they could make the most of their personal finances later on in life, when they did stop working.

Thirdly, for those with relatively small pension pots (currently, below €63,500), the pensions rules insisted that where the person wanted to access their fund before the age of 75, they would need to invest a substantial part of their pension fund in an annuity, if they did not have a set guaranteed income of at least €12,700 per year.

The conversion to an annuity would mean that the person would effectively be accessing their pension fund in dribs and drabs over the remainder of their life and, in the case of annuities (other than one providing for succession), on death, the remainder value of the fund was lost entirely.

Seeking to keep your fund intact will now be severely penalised.

For persons reaching the age of 75, or over the age of 75, the new rules will deem the PRSA or RAC pension fund to have vested, and a whopping 40% “chargeable excess tax” will apply to the fund.

If the fund is not matured (converted) by March 31, 2017, the fund is frozen, and the person cannot access it or get any benefits from it beyond that point.

The fund can only then be transferred to a successor, but in doing so, the new rules also apply a further 30% income tax (in the case of transfers to children over 21), without an option to mitigate this liability with inheritance tax-free thresholds.

Furthermore in the case of PRSAs, the new rules will impose an annual imputed distribution, meaning that not alone will such a fund be frozen, but it will erode each year, as a result of the tax on these deemed distributions.

The new rules will come into effect on the signing of the Finance Act, with some transitional procedures.

If you feel you may be affected by these changes, you should consider consulting with your financial advisor, and obtaining relevant professional advice particular to your own circumstances.

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