Money Talks: How to turn an unexpected tax bill into a nest egg for your retirement

Our reader is in a cold sweat with news that she has a tax liability of €5000 for last year. The good news is that she can offset the bill against a pension plan

Wed, 12 May, 2021 - 18:00

Carol Brick

I am a 43-year-old self-employed beauty therapist and I have been informed by my accountant that I have a tax liability of €5,000 for the 2020 tax year which came as a shock. He advised me to speak with a financial advisor regarding how I might be able to reduce or eliminate this liability by investing in a pension scheme. I have never had a pension before and would like to know how I should go about this?

I understand only too well that ‘cold sweat’ feeling you get when a phone call arrives from your accountant after they have totted up the figures at the end of the trading year. The good news is that he is correct, you now have the option to either reduce or possibly eliminate this tax liability in full by contributing to a revenue approved Pension Scheme.

First, I advise you to engage with a professional financial advisor who will do all the hard work for you in terms of best advice having obtained some additional important details regarding your situation, but I can broadly outline to you what is involved.

Look at pensions

You do not say whether you are a sole trader or a company director but as most of the clients I look after in your industry are sole traders, I am going to base my advice on that presumption.

As a sole trader, you would be entitled to open either a Personal Pension Plan or a PRSA. These are available from the major Life and Pensions Providers in Ireland and a financial advisor will be able to recommend which one to go for based on various different criteria including your own personal retirement goals, product pricing, existing arrangements, funds available and associated performance history etc.

There are age-related limits on how much you can contribute: up to a maximum of 40% for those aged 60 and over and the maximum amount of earnings that can be considered for the purpose of calculating tax relief is €115,000 per year. The tax relief payable is then at your marginal rate of tax so either 20% or 40% which is the big attraction here, obviously.

I do not have a figure for your gross earnings but let me give you a working example based on a presumed salary of €50,000.

2020 Gross Earnings: €50,000

Max Contribution Based on your age 45: 25% or €12,500.

Tax Relief at your Marginal Rate of Tax: 40% or €5,000

So, as you can see based on sample gross earnings of €50,000, by making the maximum allowable pension contribution for your age €12,500, you can fully eliminate the tax liability of €5,000 and this would also reduce your 2021 preliminary tax bill to zero also.

Consider your contribution

Of course, it may not be feasible to make a payment of this size after such a difficult trading year because of the pandemic.

It would be a good idea to contribute as much as you possibly can as there is no other legitimate investment vehicle available to you right now that will pay out an immediate return of either 20% or 40% in the form of tax relief. This is even before you invest in the markets where you will hopefully reap even more benefit’s so basically starting a pension is a complete “no brainer” really.

Let me also remind you that the state pension is approximately €12,300 per annum (that is if you are even entitled to it) and this is just above the average industrial wage so the larger your personal pension pot, the less financial burden later in life and the more realistic it will be to enjoy the retirement you have always dreamed of and more important rightly deserve.