Guard your plum pension against tax
Published 17/08/2014 | 02:30
Most of us would prefer a large pension pot to a small one. However, if you've built up a large pension pot through a defined contribution scheme, you still can't rest easy.
One of the biggest issues you must tackle is the Standard Fund Threshold (SFT). This threshold, which was first introduced in December 2005, limits the amount of tax relief you can get on your pension.
From early December 2010, it stood at €2.3m, and it was reduced to €2m in January 2014.
This means that anyone drawing down a pension over the €2m threshold this year must pay tax on the excess fund. This tax is in addition to the existing taxes payable when you draw down a pension. If not managed carefully, this could lead to an effective tax rate on the excess of up to 72pc.
Many clients say to me that the SFT is unlikely to affect them because they don't have enough money in their pension fund.
However, while a €2m defined contribution fund seems like a very significant sum, when you look at it in the context of how much income that could buy in retirement, it suddenly doesn't seem all that adequate.
Assuming that you take the maximum tax-free lump sum of €200,000 on retirement, you will be left with €1.8m out of your €2m fund to purchase an annuity. You could expect to get a pension of €45,000 a year with that €1.8m.
The Revenue Commissioners is allowing anyone who had a pension fund above the €2m mark on January 1, 2014 to apply for a personal fund threshold. That threshold, instead of the €2m threshold, will then apply to that individual. The maximum personal fund threshold available is €2.3m. So although only slightly higher than the SFT, the personal fund threshold could still save you in tax.
Many people make the mistake of overlooking the accruing value of their pension fund and not taking the right action to address that.
Here are three steps you should take to avoid doing that.
One: Check if you are entitled to a personal fund threshold and lock into the higher threshold amount now while the option is available. Since early July, you must notify Revenue online (through its electronic notification system) if you wish to avail of the personal fund threshold. You have until July 2, 2015 to do so. Notifications made on or after July 1, 2014 using the existing paper-based process will not be accepted. The new electronic system can be accessed through the Revenue online service or PAYE anytime
Two: Get advice. By planning and taking the appropriate steps at the right times, your pension fund can grow beyond the threshold without being affected by the excess fund tax. Unless you are a tax expert, you will need to get independent advice on how to do this.
Three: Plan early for retirement. It is a big milestone in your life. You need to take a long-term approach to ensure you are in a position to fund the lifestyle you wish to have after you retire.
Remember that while the SFT may discourage you from putting money into a pension scheme, saving into a pension is still incredibly tax-efficient - as long as you keep within the threshold.
Jennie Faughnan is a tax consultant with the Independent Trustee Company
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