10 Reasons Why Pensions Still Make Sense

There is no doubt that pensions are generally considered to be a pretty boring subject. They’re often wrapped up in confusing terminology and complications that people just don’t want to dedicate any time to understanding. But without fear of contradiction, pensions in Ireland remain one of the most tax efficient investing structures we have, and they offer us the best opportunity to provide for comfortable retirement planning.

There is no other opportunity available to us that offers the ability to receive a tax-free contribution from our employer while also making a tax-free contribution personally, along with your funds being able to grow tax free. 

Today, we take you through 10 reasons why pensions make sense, which we hope will encourage you to explore the opportunities they could offer to your money management plan. This article is of course for educational and guidance purposes so we would encourage to seek advice of a pensions expert before your make any personal decisions.

Of course, Thomond Asset Management welcomes any opportunity to discuss the contents of this article with you, so please feel free to contact us at any time.

1. THE STATE PENSION UNCERTAINTY

The State Pension (Contributory) personal full rate for a single person from January 2023, for a person aged 66 or over is €265.30 per week. The number of people aged over 66 is expected to keep growing over the next 35 years. This means there will be more people in retirement and less people at working age to support older generations. This will put the funding of State Pension payments under pressure. Thus, you cannot be sure the State will provide you with the same level of benefits as are currently provided. 

2. AGE TO RECEIVE STATE PENSION IS LIKELY TO INCREASE

The increase in the State Pension age to 67 from 2021 and to 68 from 2028 has been deferred pending a report due to Government in June 2021. But the State Pension age is likely to be increased again in the future.

It’s important that you look at your retirement plans and what impact it would have if you weren’t due to get the State Pension until age 67 or 68.

3. LIFE EXPECTANCY IS INCREASING

With improvements in health care and lifestyle, people are living longer, so increasing life expectancy is something to consider when planning for your retirement. Your retirement savings may need to last over 20 years after you finish working.

4. INCOME TAX RELIEF

There is significant income tax relief available on payments made personally into pension plans for those that are eligible. This tax relief is available at the higher rate of 40% on pension payments for a top rate taxpayer or 20% for a standard rate taxpayer. For a higher rate taxpayer, this is equivalent to the government topping up their net pension payments by up to 67%!

In addition to income tax relief on any personal payments, employer payments to a Company Pension are also tax deductible and no benefit in kind is appropriated to the employee. No benefit-in-kind (BIK) means, no income tax, no PRSI & no Universal Social Charge (USC) – potentially around 52% (Income tax 40% + PRSI 4% + USC 8%). Pension income in retirement is subject to income tax at your highest rate on withdrawal, USC, PRSI (if applicable) and any other taxes or government levies applicable at that time.

Income Tax relief is not guaranteed. To be eligible to claim income tax relief, your income must be taxable either Schedule E or Schedule D (case I or II). To claim income tax relief, you can apply to their Inspector of Taxes to adjust your tax credits. Pension payments deducted from salary will receive immediate tax relief. Any regular pension payments from your employer are deductible by them as a business expense for Corporation Tax purposes in the Company tax year which payments are made.

5. TAX FREE RETIREMENT LUMP SUM

Tax free retirement lump sums are available when taking retirement benefits. Those who are about to retire can take 25% of their pension fund as a retirement lump sum or with a company pension, they can instead choose to take a retirement lump sum of up to one-and-a half times their final salary, depending on the length of time employed. The maximum total tax-free amount is €200,000.

A retirement lump sum of between €200,000 and €500,000 is subject to standard-rate income tax, currently 20%. Where total retirement lump sums are greater than €500,000 these will be taxed as income at marginal rate. Someone who can take a retirement lump sum allowance of €500,000 would pay tax of €60,000 and receive €440,000 in their hand. Someone who can take a retirement lump sum allowance of €350,000 would pay tax of €30,000 and receive €320,000 in their hand.

6. PENSION LIFE INSURANCE

The same income tax relief that applies on pension payments is also available for Pension Life Insurance, which means cheaper life cover. For example, a 40-year-old self-employed non-smoker taking out €200,000 of life cover to age 65 with indexation and conversion option could choose between a term life insurance plan and personal pension life insurance.

The tax treatment of a lump sum paid out on death is the same for the term life insurance and pension life insurance. In each case the lump sum is subject to inheritance tax, and there is no tax if the lump sum is going to a spouse or registered civil partner. Income Tax relief is not guaranteed. To be eligible to claim income tax relief, your income must be taxable under either Schedule E or Schedule D (case I or II). To claim income tax relief, you can apply to their Inspector of Taxes to adjust your tax credits.

7. APPROVED RETIREMENT FUND (ARF) OPTIONS FOR ALL

The ARF options are available to:

• Members and directors in Defined Contribution (DC) Company Pensions
• Additional Voluntary Contributions (AVCs) for those in Defined Benefit (DB) Company Pensions
• Buy out Bonds from DC and DB schemes
• Personal Pensions
• Personal Retirement Savings Plan (PRSAs)

Individuals need to consider their options carefully on retirement and will need advice more than ever in this area. However, the ARF option gives what many individuals want in terms of

• control over income drawdown
• control over investment options

8. INHERITANCE PLANNING

PRE-RETIREMENT

The tax treatment of pension funds on death can result in a tax efficient way of inheritance planning. A summary of the tax treatment of lump sums paid on death is set out in the table below,

For children, the inheritance tax threshold is €335,000 per child, including any other gifts and inheritance received from parents since 1991. If a spouses, dependants or children's pension is provided this will be taxed as income. Company pensions are subject to a limit on the lump sum death benefit if the member dies while still in the relevant employment.

The lump sum limit is 4 times salary (include any retained benefits) plus a refund of their own employee contributions and AVCs. Where the member has left service with a preserved benefit* then the full value of the company pension scheme or Buy out Bond is paid to their estate on death. Also, there is no such limit for PRSAs and Personal Pensions.

POST-RETIREMENT

ARFs, vested PRSAs and vested Retirement Annuity Contracts** [RAC] are all treated the same on death. A summary of the tax treatment is set out in the table below.

TAX Treatment on death of second ARF holder

** A vested RAC is a personal pension where the individual reaches age 75 and has not taken retirement benefits.

9. GROSS ROLL UP

Exit Tax on savings and investment plans is 41%. DIRT (Deposit Interest Retention Tax) is 33%. Capital Gains Tax is 33%, with an annual exemption of €1,270.

Pension funds are exempt from Irish income and capital gains taxes (however pension income in retirement is subject to income tax at your highest rate on withdrawal, USC (Universal Social Charge), PRSI (Pay Related Social Insurance) (if applicable) and any other taxes or government levies applicable at that time).

10. INVESTMENT OPTIONS TO SUIT EVERY INVESTOR TYPE

Pensions allow for a wide range of investment options to suit every risk appetite. This includes investments in shares, property, bonds, cash, and externally managed funds. Different currencies such as Euro, Sterling or Dollar are also available.

This article is based on current pension rules, which are subject to change. Pension plans should be reviewed regularly. Independent advice should always be sought on pension planning. To claim income tax relief, you can apply to the Revenue to adjust your tax credits. Contributions deducted from salary will receive immediate tax relief. If you are self-employed, you must include your pension contributions in your self-assessment tax returns to obtain income tax relief.

Always seek the advice and support of your investment adviser before making any significant changes to your investment positions. 

This outlook and commentary do not constitute an offer and should not be taken as a recommendation from the author or Thomond Asset Management. Advice should always be sought from an appropriately qualified professional.

Warning

1. The income you get from an investment may go down as well as up.
2. The value of your investment may go down as well as up
3. Benefits may be affected by changes in currency exchange rates
4. past performance is not a reliable guide for future performance

Regulatory Status

Thomond Asset Management is regulated by the Central Bank of Ireland as an Investment Business Firm under Section 10 of the Investment Intermediaries Act, 1995 (as amended) and registered as an insurance, reinsurance or ancillary insurance intermediary under the European Union (Insurance Distributions, 2018).