Optimize tax relief on pension contributions

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In every conversation I have with clients considering retreats, two questions are always asked:

  • Should I start a pension now?
  • How much should I invest?

My personal take on the first question is that it depends on the person’s personal and financial situation at the time. For example, if you are saving for a mortgage or are about to start a family, these costs will be greater in the short term, and perhaps postponing your retirement will suit your financial needs better.

However, if you are able to invest your surplus / cash, an annuity will provide you with a tax-efficient savings plan for your retirement. This leads to the second question, how much should I invest.

Retirement investments are very tax-efficient compared to a normal savings plan. The difference is that you get tax relief based on the maximum rate of income tax you pay. For example, a person paying 40% income tax on their income will get a tax break of € 40 for every € 100 invested (or € 20 if they pay 20% income tax). Therefore, when determining how much to invest in a year, you need to make sure that you get the maximum tax efficiency from that contribution.

However, the amount of tax relief available on annual pension contributions is capped depending on the income and age of the contributor during that year.

So what income (relevant net earnings) is assessed to determine the maximum pension tax relief available?

Relevant Net Gains (NRE) Relevant net gains are the relevant gains (employment income, business income of the self-employed) less losses, capital deductions and charges that are offset to reduce an individual’s taxable income at the time. during a fiscal year.

Rental profits or investment income such as deposit interest / dividends are not part of the relevant income and therefore the tax on these cannot be reduced by the pension contributions paid.

In addition, in recent years the relevant net income figure eligible for tax relief has been capped at € 115,000. For example, a 35-year-old taxpayer who earns € 150,000 per year will be limited to claiming tax relief on € 23,000 of pension contribution (€ 115,000 * 20%).

When during a year, an individual is limited to the tax relief to which he is entitled by virtue of the above limits, this excess contribution amount may be carried forward to be claimed in subsequent years.

Individuals’ contributions to their private pension funds (including stroke) before October 31 (or later if reported on ROS) in a year can be used to claim tax relief on tax paid the previous year. For example, a taxpayer at the maximum rate (40%) who can invest an additional € 10,000 in a retirement contribution before October 31, 2021 (or online ROS – November 17, 2021), can obtain an income tax refund of € 4,000 from the tax year 2020. This would result in a net cash-out of € 6,000 in October 2021.

Company pension plan

In addition to the tax allowance on personal pensions (PRSA, RAC), when the employer of an individual contributes to the retirement of an employee under a company pension scheme, the individual is not subject to tax on employer contributions.

This results in no taxable benefit for the employee. One of the main advantages of the company pension plan is that the employer’s contribution does not reduce the employee’s tax relief limit stated above. However, employer contributions to company pension schemes must be within prescribed limits. This contrasts with the employer’s contributions to a PRSA which are combined with the employee’s own PRSA contributions to calculate the employee’s maximum tax relief limit.

As part of the company pension plan, an employer usually sets the rates at which it will contribute to the employee’s pension fund. The employee will then pay his own contributions to the fund on the basis of a fixed percentage of his salary. When an employee wishes to increase their own contributions to the fund, they can do so by making voluntary supplementary contributions (CFS) to the fund. Again, the employee should be aware that these CFS payments must be within the above tax relief limits to ensure the most tax efficient contribution.

Access the retirement fund

The majority of holders of a personal pension or a PRSA should be entitled to withdraw a maximum lump sum of 25% from the fund upon retirement. In the case of holders of a company pension scheme, they should in some cases be able to receive 1.5 times their last salary in the form of a lump sum.

Currently, the maximum lump sum that an individual can receive tax free is € 200,000. This is a lifetime limit and therefore applies to all pension funds collectively, regardless of whether lump sums are withdrawn at different times from different pension funds by the individual.

For individuals whose capital exceeds € 200,000, they can obtain the following € 300,000 (€ 500K-€ 200K) at the tax rate of 20%. For lump sums greater than € 500,000, the excess is taxable at the marginal rate of the individual tax.

The balance of your pension fund will be used to buy an Annuity (life income), an ARF / AMRF, or take as taxable capital. Tax on annual annuity payments or ARF / AMRF withdrawals will then be taxable on the basis of the individual’s annual income at that time.

Retiring Family Business Owners Too often we treat our businesses like family, and like family, we hope that they will continue to grow and develop and be even more successful when we are. more there. And this is where I find pensions to be a welcome distinction from business assets transferred to the next generation.

Many business owners who retire are often concerned that the business they are about to part with will need the business cash they have accumulated to continue or grow. This view more often than not makes the owner feel somewhat guilty at the suggestion to withdraw the company’s own cash reserves to help them in retirement.

However, a pension fund is never viewed by business owners as part of the business assets, and for that reason alone it provides additional financial security for the retiring business owner. and who is in such a situation.

Conclusion

In a country with an aging population, it is inevitable that at some point in the future the state pension will come under greater pressure. These pressures may very well lead to a reduction in the pension rates paid or an increase in the retirement age for its citizens. Therefore, anyone wishing to protect their own retirement, a private pension is definitely a tax relief option to consider.

Brian Harty of Harty Tax Consulting.
Brian Harty of Harty Tax Consulting.

Brian Harty, Director, Harty Tax Consulting, Cloyne, Co Cork. www.hartytaxconsulting.ie


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