Pension and Tax
Pensions in Ireland are tax driven, they shouldn’t be but the reality is that more self-employed individuals pay pension premiums in the six weeks between the start of October and the middle of November than they do for the other forty six weeks of the year.
There is one simple reason for this, people dislike paying tax, advisors spend a lot of time talking about retirement, but tax is a massive driver of pension planning. It is a fallacy that the state will look after you in retirement, while plans are currently stalled to increase the state pension age to 67 and then to 68, in all honesty a state pension will not give you enough income in retirement and the state has mitigated this by incentivising pension saving through the income tax system.
Why then are those six weeks so busy from a pension perspective?
Truth be told anybody who’s accounts are in order could pay their tax bill for 2019 (some do) as soon as the accounts are done, us Irish love a deadline though, For Self Employed individuals and people in Partnerships the Income Tax Return (deadline for 2019’s income is the 31st of October 2020.
If you file and pay your taxes online, the deadline is usually mid-November, this year due to Covid 19, Revenue has decided to further extend this deadline to Thursday, 10 December 2020, these deadlines also apply to pension contributions.
Are there limits for tax relief on pension contributions?
Yes, there are. Tax relief for employee pension contributions is subject to two main limits:
- an age-related earnings percentage limit
- a total earnings limit.
Age-related earnings percentage limits
You can get tax relief up to the relevant age-related percentage limit of your earnings in any year.
You might have more than one source of income. If you do, this relief is only from the source of income in respect of which the contributions are made.
For example, an individual who is aged 52 and earns €60,000 can get tax relief on annual pension contributions up to €15,000.
The age related limits are listed below
| Age | Percentage limit |
|---|---|
| Under 30 | 15% |
| 30-39 | 25% |
| 40-49 | 30% |
| 50-59 | 35% |
| 60 or over | 40% |
Total earnings limit
The maximum amount of earnings taken into account for calculating tax relief is €115,000 per year. In effect this means that any income above €115,000 is deemed ineligible for pension purposes.
As you can see from the tables the tax savings for a middle to high earner are generous, especially when you consider that growth within a pension fund is not taxable and on retirement you are able to access up to 25% of your fund (employees and directors have other options), there are three exceptional tax advantages to investing in a pension as opposed to investing elsewhere.
Pensions a 25% or 66% increase in initial value for every contribution.
There is an awful lot of space dedicated to investment returns, fees, charges, asset allocations etc when it comes to pension investments and all of these are relevant and need to be explored and understood, however the one fundamental that is poorly projected is the initial return on investment.
If you are paying Income Tax at 40% consider the actual amount you are investing as opposed to the tax relief, you are getting. If you invest €1,000 into a pension, the net cost to you is €600, the tax relief on eligible contributions means that you have an equivalent return of 66% on your net contribution, irrespective of returns, fees, charges etc and that is before it is even invested and working for you.
If you are paying Income Tax at 20% the benefits are not as impressive (but still nice), your €1,000 has a net cost of €800, the tax relief on eligible contributions means that you have an equivalent return of 25% on your net contribution.
Reticence about Pensions
People don’t like pensions; I have heard a raft of stories as to why they don’t like them. Quick examples being confusion, so many different types of pension, which one is the right one. Barstool (remember them) stories, I had a pension, and it was wiped out in the crash, I lost it all etc. Can’t afford one, too risky, to complicated, my house is my pension
If you want two reasons to pay into a pension think, 66% initial return and the state pension won’t be enough to keep you comfortable.
Personal Pension Term Life Assurance
This is a pensions piece, so why am I mentioning Pension Term Assurance, depending on medical underwriting, if you are considering paying into a pension and you are not in a company pension scheme as part of your overall financial review, your advisor should be looking at you life cover benefits. A Section 785 or Pension Term policy is a plan that is structured to use the tax relief that is currently available under pensions legislation, even if you don’t have a pension plan. It is much more cost efficient than traditional Term Plans.
Example
An individual Non Smoker, aged 41 taking out a €300,000 convertible term plan to age 66 would pay an annual premium of €420.28 per annum with Aviva Life, if they elected to take out a Convertible Term Pension Term Plan the gross premium would be €423.76 again with Aviva, and the next premium for a 40% tax payer would be €254.26 per annum, if the individual was taxed at 20% the premium would be €339 per annum.
Those are annual savings, there are a few caveats to implementing a Pension Term plan before a revenue deadline and that is the premium must be received before the deadline so only consider this if you are in good health as any underwriting could cause a delay in the start of the policy. The other caveat is that as the policy is written under pension legislation it cannot be assigned as security for a loan or for any other reason.
BIO
Mike Knightson QFA, CFP®, RPA, MIIPM, SIA
Mike is a Certified Financial Planner with over 20 years’ experience in Financial Services advising clients on their Financial Affairs, he is the Limerick Regional Chairperson for the Life Insurance Association of Ireland and sits on the Ethics board of St. Josephs Foundation.
In 2016, he set up KM Financial with his business partner David Mulvihill. They have offices in Charleville, Co. Cork and Dungarvan, Co. Waterford.
KM Financial provides advice on Retirement Planning, Financial Protection, Saving and Investment advice to individuals, self-employed businesspeople, company directors and retirees. For further information you can check their website https://kmfinancial.ie/ or email him [email protected]