Taxing questions
The Commission on Taxation has made recommendations for an SSIA-style pension to benefit those on lower incomes -- but at what cost to middle-income earners, asks Charlie Weston
It will be a while before Siofra Lynch draws a pension, but the pensions landscape will have changed a lot by then.
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MIDDLE income earners are set to be the big losers if proposals on pensions from the Commission on Taxation are implemented.
The commission is proposing radical changes to the way pension tax reliefs work in this country.
The report calls for a new SSIA-type pension to be introduced for the lower paid with the State putting in €1 for every €2 a worker puts into this new retirement scheme.
It will be called a Retirement Savings Scheme (RSS).
This scheme would give a major incentive for those on low income to provide for their retirement.
However, the losers are set to be those on the higher rate of tax who currently pay into a pension.
These changes would particularly affect the self-employed and those whose employer does not provide meaningful pension provision for them.
A new tax relief rate of 30pc would apply for those already paying into a pension, the commission proposes.
This "hybrid" rate would straddle the 20pc tax rate and the marginal 41pc rate.
This would result in those on the 20pc income tax rate getting more tax relief, but those on the 41pc rate would get less tax relief for their contributions.
So, higher-rate taxpayers paying into private pensions would lose out heavily.
Public sector workers should be relatively unaffected as the majority of their pension contributions are made by the State. This means changes in the tax reliefs regime for pensions would have no real bearing on them.
Also likely to escape unscathed, if the proposals are put in place, are those in a position to be a controlling director in their own company.
These people can engineer it so that the company puts virtually unlimited amounts of money into their pensions.
Assets as diverse as property, art and shares can be put into this type of pension and still qualify for tax reliefs. The only limit is that the pension fund cannot be bigger than €5.4m for tax purposes.
Others who would not be impacted by the commission's proposals are those workers who are members of a company pension scheme and have annual contributions made on their behalf by their employer.
In the case of those fortunate enough to belong to a defined benefit scheme, this might be as much as 50pc or more of their annual pensionable salary -- a figure which also gives us some insight into the underlying cost of providing public sector pensions, according to managing director of Deloitte Pensions, Ian Mitchell.
But those on middle incomes who pay into a pension would be less inclined to do so if the commission's recommendations are implemented.
Currently, someone paying tax at the higher 41pc rate can claim this back and also claim PRSI (4pc) and the health levy, which is 4pc up to €75,036.
Couple
This means that they get €100 put into their pension at a net cost of just €51 -- although once the funds are actually drawn out of the pension scheme on retirement the individual will have to pay tax on their then tax rate on the annual income generated.
Workers start paying tax at the higher rate on relatively low levels of income in this country.
A single or widowed person starts to pay tax at the 41pc rate from €36,400.
A married couple with one income pays the marginal rate on income over €45,400, and a two-income couple pays it on income over €72,800.
Under the commission's proposals, tax relief on pensions would not be available at the higher 41pc rate, but instead at 30pc. Relief would still also be available on PRSI and health levy payments.
This means the most that could be claimed by a higher-rate taxpayer would be 38pc -- made up of 30pc tax relief, 4pc PRSI and 4pc health levy.
Capping the tax rate at which higher-paid workers could claim pensions relief would mean generating a pension pot of €100 will then cost €62.
This prompts the question: Why would anyone defer income until they are 65 if they have to pay some tax on it?
The current marginal rate of tax is 54pc -- made up of a tax rate of 41pc, PRSI of 4pc, health levy of 4pc up to income of €75,036, and the income levy.
The income levy is not deductible for pension purposes.
So, paying into a pension you would get relief of 38pc, but you may be paying tax at the margin of 54pc.
Mr Mitchell says: "This potential removal of the 41pc tax band will totally remove any incentive for the higher rate taxpayer to provide for her or his pension.
"Why would anyone defer income until age 65 if they had to pay 16pc tax on it now (a marginal tax of 54pc once you include levies -- less the 38pc relief and levies)?
"They would then potentially pay another 54pc when the income is drawn down after age 65?
"So unless they also change the income tax rules that all pensioners will pay 30pc tax on all pension proceeds to mirror the 30pc deferment benefit (because it's not relief really, just a deferment until the income is used) this initiative will actually create a significant bias towards the lower paid."
The commission does not recommend moving to the lower tax relief on pensions of 30pc immediately. Instead, it wants this brought in over the medium to long term.
