The attractiveness of an early retirement package can hinge on how tax efficient it is
The attractiveness of the early retirement package can depend on how tax efficient it is and so it's critical to take clear advice before making the decision to accept it, writes Barry Kennelly
EARLY retirement is becoming an option for an increasing number of people as employers seek to cut costs where possible.
However, before taking early retirement you should sit down and go through your finances to assess your financial status and calculate your financial needs over the long term.
You need to be fully confident that you understand what is on offer.
Some employers are offering attractive cash sums up-front to encourage employees to take early retirement. However, you need to make sure that it is really as attractive as it sounds.
For example, you should clarify if this is a genuine termination payment for leaving your employment or if it is going to be deducted from your existing pension fund.
If it's a genuine termination payment then it represents a real increase in your assets.
However, if the lump sum is purely coming from your pension fund then you may be simply taking what you are already entitled to under your pension scheme and thus will not really be getting anything extra.
Sometimes the distinction isn't immediately obvious.
For example, is your employer due to make extra payments into your pension fund? If so, the payment promised to you may be in lieu of the pension fund payments.
Again, this is effectively paying you with your own money.
Assuming you can satisfy yourself that the offer of additional cash is real you will need to see what losses you are likely to suffer.
Apart from the obvious loss of salary, you should also be aware of the loss of pension benefit.
Both your salary and years of service will be curtailed by your departure with a knock-on impact on the amount of the tax-free lump sum and pension you might have received.
In addition, early retirement benefits are further reduced to allow for the additional costs of paying benefits early and for a longer period.
This additional penalty can be as high as 5pc of your annual pension for every year you fall short of the statutory retirement age.
Therefore, if you were scheduled to receive a pension of €40,000 per annum at the age 65, this might be only €20,000 if you were to retire at age 55.
This potential discount can be offset by negotiation. In addition, your pension benefits can actually be enhanced by leaving early.
For example, you may leap frog other members in terms of priority and thus have more secure benefits.
Having locked down the pension benefit you now need to decide what to do with it. For example, should you take the tax-free cash?
The answer is not as simple as might first appear -- the amount taken in tax-free cash from your pension fund can reduce the amount of the termination payment that is tax-free.
Ultimately the attractiveness of the early retirement package can hinge on how tax efficient it is so it is critical to get clear advice on this issue.
If you do choose to take the lump sum on offer from your pension fund, your next decision will be what to do with the balance of the fund.
If you are a member of a defined benefit scheme this will entitle you to an annual pension which should be specified. However, you should probe further into this and ask questions including:
- Does it provide for a spouse's pension?
- Does it increase in line with inflation?
- Can the additional voluntary contribution fund be used to buy an annual pension or can it be invested into an approved retirement fund (ARF)?
An ARF offers flexibility in terms of what it is invested in and when income is drawn.
The balance remaining in the fund passes to your family on death.
You will need to be clear which of these options best suits your needs.
- Barry Kennelly, Senior Consultant, Astons Tax & Wealth Consultants