Saturday 22 September 2018

Future proofed: your ultimate guide to pensions

A mere four in ten workers are in pension plans, despite the tax advantages and the financial realities of longer retirements. Here the Deloitte team reveal what you need to know

‘The motivation behind an individual’s focus on pension matters varies depending on that individual’s stage of life (stock photo)
‘The motivation behind an individual’s focus on pension matters varies depending on that individual’s stage of life (stock photo)

Deloitte team

1. Introduction: Let’s start with the good news — we are living longer than ever before. Latest statistics suggest that men and women in Ireland can expect to live to 81.5 years on average. There’s no downside to a longer life, right?

Consider this — longer life means we will need to provide ourselves with an income for a longer period of time post retirement.

We might quip about kids paying for our nursing homes, but we all know that it is our own responsibility to provide for our own retirement. Building your personal pension fund is the obvious answer — remember, at current maximum rates, the State pension provides an income of only about one-third of average annual earnings.

Pensions are a complex area but they should not be neglected. The earlier and more you contribute, the more likely you are to achieve financial security in retirement. There is a sound reason that actuaries and the Government actively encourage people to think about pension planning sooner rather than later.

So, regardless of whether you are just starting out on your career path or getting close to retirement, you should be planning for your retirement now. It is a topic that has to be considered by everyone at some stage.

However, the motivation behind an individual’s focus on pension matters varies depending on that individual’s stage of life.

For example, a 25-year-old is likely to be more enamoured by the thought of the tax relief available on contributions to a pension fund, while a 55-year-old is likely to be thinking about the ultimate payout and benefits from the fund.

This article aims to simplify matters by providing information in sections so that you can cut to the part relevant to you, and hopefully the ‘jargon buster’ will help to explain the meanings of certain pension-related terminology.

2 Jargon buster

Additional Voluntary Contributions (“AVCs”)

AVCs are extra contributions you make in addition to the normal pension contributions made by you and/or your employer. Tax relief is available in the normal manner.

Annuity

An annuity is a contract with a life assurance company that will pay you a guaranteed regular pension income for the rest of your life.  The amount of the annuity depends on the amount paid in on retirement, annuity rates, age, gender and state of health.

Approved Minimum Retirement Fund (“AMRF”)

Before you can take out an ARF, up to €63,500 of the fund must be used to purchase an AMRF. Only the investment growth can be accessed or drawn down on an AMRF before the age of 75.

Approved Retirement Fund (“ARF”)

An ARF is a personal retirement fund that gives more control over how your retirement fund is managed. You can withdraw from it regularly to give yourself an income, on which you pay income tax, Pay Related Social Insurance (“PRSI”) and Universal Social Charge (“USC”).

Defined Benefit (“DB”) scheme

This is a type of pension plan that pays pension income based on your final salary and number of years of service with your employer.

Defined Contribution (“DC”) scheme

This is a type of pension plan that builds up a pot to pay you pension income based on contributions by you and/or your employer and investment returns.

Normal retirement age

See section 3.

Occupational pension scheme

A pension scheme set up by an employer to provide retirement benefits for employees.

Personal Retirement Savings Account (“PRSA”)

A PRSA is a type of personal pension policy available from banks, life assurance companies, and through brokers. It is more flexible than a traditional personal pension plan. Used by members of occupational schemes for AVCs. Also used instead of a RAC.

Retirement annuity contract (“RACs”)

Traditional vehicle for pension funding by self-employed or employees who are not members of an occupational pension

Small self-administered pension scheme (“SSAP”)

A type of occupational pension scheme that can have up to 12 members. Generally just one member.  Individuals can have more influence over investments.

3 What does retirement actually mean?

Pension type

Usual retirement age

State pension66 years
Public sector pension60 to 65 years
Occupational pension scheme60 to 70 years

 

A scheme may also provide for “early retirement” in certain circumstances.  In general, where pension benefits are taken early under “early retirement” arrangements, the relevant employment must cease.

4 Rates

The current rates of contributory State pension varies from €97.20 to €243.30 per week.  An additional €10 per week is paid when you reach 80 years of age.  There are also additional payments available in certain cases where you care for dependent qualifying adults or children. 

The State pension is approximately one-third of average annual earnings.

The contributory State pension is taxable.

Conditions for qualification

Entitlement to the State Pension (Contributory) is based purely on PRSI contributions during your working life to age 66. It is not means-tested.

In order to qualify for the contributory State pension, the following conditions must be satisfied:

1 You must have started paying PRSI 10 years before reaching pension age (currently age 66);

2 You must have 520 full-rate contributions (10 years).  This includes contributions to class A and class S. Only 260 contributions can be made up of voluntary contributions; and

3 You must have an annual average of at least 10 contributions per year from the year you first entered insurance to the end of the tax year before you reach pension age.  An average of 10 contributions entitles you to the minimum pension, while an average of 48 contributions entitles you to the maximum pension.

New arrangement for pensioners on reduced-rate pensions

People who applied for the contributory State pension after 1 September 2012 and who received a reduced pension due to contribution gaps for homemaking and caring will be reassessed and can avail of a new Homecaring Credit.

Under the new regime, credited contributions will be available for periods of up to 20 years of homemaking and caring duties. Periods include time spent caring for children up to age 12, and for a person of any age who requires full time care and attention may be included.

The Department of Employment Affairs and Social Protections are contacting the affected individuals by post towards the end of 2018. You do not need to take any action until you receive this letter. The first payments will be made in 2019, with payments backdated to 30 March 2018. 

Time worked outside Ireland

Where you have worked in Ireland and certain other jurisdictions (EEA, Switzerland, Canada, USA, Australia, New Zealand, Austria, Japan, Republic of Korea), the social insurance contributions in each relevant jurisdiction can be relevant to determining your State pension entitlement.

Application

To ensure State pension payments commence on time, the Department of Employment Affairs and Social Protection advise that applications should be submitted three months before the age of 66.  Where you have paid social insurance contributions outside Ireland, applications should be submitted six months before reaching 66.

What if I don’t qualify for a (full) Contributory State pension?

If you do not qualify for a Contributory State pension, or if you only qualify for a partial pension, you can apply for the non-Contributory State pension, which is means tested.

Pension reform

As mentioned above, the State pension age is currently set at 66. This is due to increase to 67 years of age from 2021 and to 68 years of age from 2028.

With Ireland’s ageing population, coupled with the fact that only one in three private sector workers has a personal pension policy, the Government is seeking to encourage people to plan for retirement.

The Government has launched “A Roadmap for Pensions Reform” to run from 2018 to 2023.  A number of different aspects have been proposed including:

• A new method for calculating an individual’s entitlement to the State pension from 2020 outlines a potential move from the current “yearly average” system to a “total contributions” approach. This includes awarding significant credits to people who have taken time out to perform caring duties;

• An actuarial review of PRSI rates, together with the amalgamation of USC and PRSI;

• Review of life expectancy in 2022 (and every five years thereafter) with a view to alignment with the State pension age.  The Government has pledged that any change to the State pension age in light of these reviews would be subject to a 13-year notice period, ie 2035 at the earliest;

• Indexation of the State pension rates; and

• Introduction of a mandatory automatic enrolment retirement savings system see section 10 below).

Under this umbrella, The Pensions Authority has also been tasked with making pension rules easier to understand and removing anomalies in the current system.  A reduction in the number of products is being considered. 

5 Revenue-approved pension schemes

The current rate of State pension provides an income that equates to only 34pc of average earnings. Therefore, the Government provides tax reliefs for certain Revenue approved pension products to encourage people to make additional savings for retirement. The different types of scheme are listed:

Type of Scheme

Participators

Contributors

Public sector pension schemesEmployees of government departments, State bodies and State companiesEmployees (optional)
Occupational pension schemes (including SSAPs)Operated by employers for employees working in the private sector

Employers (mandatory)

Employees (optional)

RACsTraditional vehicle for pension funding by self-employed individuals or employees who are not members of an occupational pensionIndividual contributions only
PRSACan be used instead of a RAC. Also used by members of occupational schemes for AVCsIndividual contributions generally, including from self-employed individuals. Employer contributions are possible but are regarded as income of the employee and included as employee contributions for tax purposes

 

6 Tax relief

Pension type

Employee contributions

Employee/individual contributions

Occupation pension

• Employer must make a meaningful contribution

• Tax deduction available for employer

• No income tax/USC/PRSI for employee on employer contribution

• Income tax relief only
RAC• Employer contribution not permitted

• Income tax relief only

• “Net relevant earnings” are relevant

earnings less losses and capital

allowances and charges on income

not deducted elsewhere

PRSA

• Tax deduction available for employer

• Employer contribution regarded as taxable income for the employee

• Income tax relief only on both employee and employer

• Employer PRSI not chargeable on employer contribution

 

How much tax relief can I claim?

An individual’s earnings are currently capped at €115,000 for the purpose of granting tax relief. The maximum relief available is based on the following age-related factors:

Age

percentage of capped income

Maximum tax relivable contribution

Value of maximum tax relief at 40pc

Under 30

30 to 39

40 to 49

50 to 54

55 to 59

60 and over

15pc

20pc

25pc

30pc

35pc

40pc

€17,250

€23,000

€28,750

€34,500

€40,250

€46,000

€6,900

€9,200

€11,500

€13,800

€16,100

€18,400

 

You may make a once-off pension contribution (known as AVCs) after the end of the tax year but before the following 31 October and elect to claim the tax relief in the earlier tax year.

For example, an individual is 34 years of age and made pension contributions of €15,000 through payroll during 2017.

Provided the individual has sufficient earnings, an AVC of up to €8,000 can be paid before 31 October 2018 to avail of the maximum tax relief on filing a 2017 tax return.

Where you make contributions in excess of the above limits, the tax relief is carried forward to the following tax year.

7A Defined benefit scheme versus defined contribution scheme

Occupational pension schemes are either a defined benefit (“DB”) scheme or a defined contribution (“DC”) scheme. Nowadays, DC schemes are most common. A DB scheme promises a fixed benefit on retirement.

The benefit is broadly based on an employee’s years of services and final salary. The fixed benefit to be provided varies across schemes. 

Generally, DB schemes in the private sector provide for an annuity calculated as 1/60th of final salary multiplied by number of years of service, up to a maximum of 40 years’ service.  This can usually be reduced by taking a lump sum on retirement.

Public sector DB schemes tend to provide for a lump sum of 3/80th‘s of final salary multiplied by number of years of service, and an annuity of 1/80th of final salary multiplied by number of years of service, both of which are subject to a maximum of 40 years’ service.

A DC scheme invests the contributions made to the scheme, including both employee and employer contributions where relevant, to provide a retirement benefit. The benefit is largely dependent on how the investments perform. The investments are managed by the pension trustees. Contributors generally have no influence over the investment plan.

8 Drawdown of pension benefits

The precise pension benefits available at retirement depends on the type of scheme and the specific scheme rules:

Lump sum....

Type of schemeComment
Public sector schemeA mandatory lump sum of up to 1.5 times salary
Defined benefit occupational schemeUp to 1.5 times final remuneration (salary plus fluctuating emoluments). Note — where an individual has been a director who owned shares with greater than 5pc of the voting rights in the last three years, 25pc of the fund can be taken as a lump sum (instead of a lump sum based on final remuneration)
Defined contribution occupational schemeMaximum of 25pc of the fund
RAC / PRSAMaximum of 25pc of the fund

 

AVCs can be used to provide an additional lump sum. The lump sum is taxed as follows:

First €200,000: Exempt

Next €300,000: 20pc tax

Balance: 48pc tax

 

Tax paid at the standard rate on a lump sum is creditable against the tax due on the excess over an individual’s SFT/PFT (see section 10 below).

Annuity pension

Under a public sector scheme, the annual pension is calculated by reference to salary and length of service. The maximum level is 50pc of salary.

For occupational pension schemes, a pension of up to 1/60th of final remuneration for each year of service (usually up to a maximum of 40 years) can be provided.  This is reduced to take account of any lump sum received.

AVCs can be used to purchase additional pension, within the maximum limits.

A pension is taxable through the PAYE system at the individual’s marginal rates, ie up to 48pc (being income tax and USC). PRSI does not apply to pensions. 

Taxable cash

Provided either the minimum pension or AMRF condition is satisfied (see below), the balance of the following private sector schemes can be taken as taxable cash as an alternative to purchasing a pension:

• Defined benefit occupational scheme for directors with more than a 5pc shareholding in the company;

• Defined contribution occupational scheme;

• RAC; and

• PRSA.

Cash is taxable through PAYE at the individual’s marginal rates, ie up to 52pc if under age 66 and up to 48pc if over age 66.

Transfer to ARF / AMRF

An individual who wishes to take the balance as taxable cash or as an ARF transfer before reaching 75 years of age must have a minimum annual guaranteed pension income of €12,700.  Where this cannot be demonstrated, an amount of €63,500 must be transferred to an AMRF or used to purchase an annuity pension.

Once the minimum annual pension or AMRF condition is satisfied, the balance of all private sector pension schemes (mentioned under the heading “taxable cash” above) can be transferred to an ARF. An ARF is your personal property.  The residual value at death goes to your estate.

The transfer to an AMRF/ARF is not taxable in itself. Withdrawals from these funds are taxable in the same manner as taxable cash. 

In the case of an ARF, there are deemed minimum annual withdrawals from age 60 as set out below:

Value of ARF Under Age 7070 and over

Up to €2m

Over €2m

4pc   

6pc

   5pc

   6pc

Withdrawals and deemed withdrawals from an ARF are taxable under the PAYE system.

In the case of an AMRF, it is possible to withdraw up to 4pc of the fund every year, subject to tax under the PAYE system.

An AMRF becomes an ARF at the earlier of reaching age 75, receiving an annual pension of €12,700 or death.

Spouse and dependants pension

Some schemes provide for a spouse and dependants pension.  This will depend on the individual scheme rules and the choices made at retirement.

9 Public sector pensions

Public sector employees contribute to pension schemes in the same manner as employees in the private sector. The main difference is that “employer contributions” are funded by the Exchequer.

Pension Related Deduction (“PRD”)

The PRD, sometimes referred to as the pension levy, was introduced on 1 March 2009. 

The following PRD rates are applicable since 1 January 2017:

Amount of remuneration

PRD rate

Up to €28,750

€28,751 to €60,000

Over €60,000

Exempt

10pc

10.5pc

 

The PRD is treated as an allowable deduction for tax and USC purposes. There is no relief for employee PRSI. This does not affect the maximum level of pension contributions an individual can make.

Additional Superannuation Contribution (“ASC”)

The PRD will be replaced by the ASC from 1 January 2019.  The PRD was a levy that was imposed on public servants under the Financial Emergency Measures in the Public Interest Acts. It is not a pension contribution. The ASC is treated as a pension contribution and is intended to attract the same marginal rate of tax relief applicable to Revenue-approved pension schemes.

Different rates of ASC will apply to public sector workers who are members of pre-2013 pension schemes versus those who are not. The proposed ASC rates are as follows:

Amount of remuneration

ASC rate

Pre-2013 members

All other members

Up to €32,000

€32,001 to €60,000

Over €60,000

Exempt

10pc

10.5pc

Exempt

6.66pc

7pc

 

10 Auto-enrolment

Despite advice from government and actuaries, and regardless of the tax relief available, only about 40pc of the workforce are members of pension schemes. 

Therefore, the Government is to introduce an auto-enrolment regime whereby employees will be automatically included in a pension scheme (unless they opt out).

Such regimes have already been introduced in Australia and the UK.

The Government action plan, “A Roadmap for Pensions Reform”, provided for the introduction of auto-enrolment by 2022 with the contribution rate likely to be 14pc, to be funded as follows:

Contributor Rate of contribution

Employee: 6pc

Employer:6pc

Government:2pc

Total contribution:14pc

Note – it is intended that the Government contribution will replace rather than augment the existing tax reliefs. 

This would suggest that the employee contribution will be payable from net after-tax pay.

11 Tax charge on high value pension funds

The Standard Fund Threshold (“SFT”) is the maximum tax-relieved pension fund value an individual is permitted.  It was first introduced in 2005 and is currently set at €2,000,000. This is a lifetime limit and includes all pension benefits. The previous SFT levels are as follows:

Date of change

SFT

Introduction: 7 December 2005

2006

2007

2008 to 6 December 2010

7 December 2010 to 2013

1 January 2014 to date  

€5,000,000

€5,000,000

€5,165,000

€5,418,085

€2,300,000

€2,000,000

 

12 What happens if I move abroad?

In general, the tax treatment outlined above continues to apply in Ireland.

However, if there is a double taxation agreement between Ireland and your new country of residence, the Irish tax treatment can be different.

Most double taxation agreements provide that the pension is to be taxed only in the country of residence. 

In this event, the payor should obtain permission from Revenue to pay the pension without deduction of PAYE. It should be noted that Revenue always treat ARF/AMRF withdrawals as taxable, as they are not pensions.

Local tax in your country of residence should not be overlooked — it is likely to be payable.

Some people seek to transfer their pension funds abroad. Specific advice should be sought by anyone considering a transfer abroad.

 

Compiled by Billy Burke, Partner, Global Employer Services; Niamh Barry, Manager, Global Employer Services; Ian Prenty, Director, Global Employer Services; and Donncha Dillon, Senior Manager, Global Employer Services, Deloitte

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