Sunday 17 December 2017

What will tax bill be on pension lump sum?

 

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Jerry Moriarty CEO of the IAPF (www.iapf.ie)

Q It looks like I will be getting a pension lump sum of more than €500,000 when I retire. I know that only €200,000 of this will be tax-free. What kind of tax will I have to pay on the balance over €200,000? Cathal, Rochestown, Co Cork

The amount of cash you can take out of a pension arrangement is limited, with different rules applying - depending on the type of arrangement you have.

You are correct in believing that the first €200,000 of your pension lump sum will be currently tax-free. Bear in mind, however, that the rules governing tax are subject to annual review in the Budget.

The €200,000 represents your total lifetime limit - so if you have taken lump sums from previous employments or pension schemes in the past, you will need to allow for these. You might also have some restrictions if you have ever received redundancy payments.

Lump sums between €200,001 and €500,000 are currently taxed at 20pc - with any balance over this amount taxed at your marginal rate and subject to the Universal Social Charge. So, in your case, you will pay about €60,000 in tax, which is pretty good considering that you probably got tax relief at the marginal tax rate on your contribution over the years.

The amount of cash you take out tax-free from an occupational pension scheme at normal retirement age is generally one-and-a-half times your final income - if you have completed 20 years' service and have no benefits from a previous scheme. If your pension money is in a Retirement Annuity Contract or a Personal Retirement Savings Account or if you plan to transfer to an Approved Retirement Fund, the cash limit is 25pc of the retirement fund.

Expert advice on saving

Q I'm 26 and I've just started a defined-contribution pension scheme with my employer where we're each putting 5pc of my salary into the pension. I'm wondering if I have any choice about where my savings are invested and whether advice is available to help me understand where my investment will go? Ideally, I'm looking for high growth and low risk. Tom, Portobello, Dublin 2

Firstly, well done for starting pension saving so early in your working life. Not enough people do so and as a consequence, many of them will have a relatively small pension to live on in retirement. Starting early makes a huge difference as your savings will be invested for over 40 years.

Most employer defined-contribution pension schemes will have several investment funds from which you can choose. If there is a choice, there also has to be a default fund which you will automatically be put into if you can't - or don't want to - make a choice.

Your pension provider, or the trustees who look after your pension scheme, should give you lots of information when you first join the scheme. That information should include the funds involved and the options available to you. It's imperative that, at this point, you get expert advice and fully understand the choices that you are making. You may be able to talk to the scheme's administrator who can explain the options to you - or you may seek independent financial advice.

Typically, low-risk investment is accompanied by the expectation of low returns and vice versa - it is generally impossible to achieve high growth with low risk. While attitude to risk is very personal, with 40 years or more to go to retirement, and a relatively small amount in your fund for the first few years, many people at your stage typically take more risk to begin with - as you are investing for the long term.

Once your choices are made, it's important to review your investment choices periodically. It would be wise to review those choices at least every five years. It is quite likely that you will automatically be moved to safer investments as you approach retirement.

Options after changing job

Q I am changing jobs. I am only 35 and have about €80,000 in my current company pension. I'm considering moving this to either a Personal Retirement Savings Account (PRSA) or a Personal Retirement Bond. Is this a good idea - or is there a better option? Niamh, Killarney, Co Kerry

You highlight an issue that we come across all too frequently: the complexity of so many pension arrangements and rules that were written in a time when people stayed in the one job for life.

As it stands, however, you do have a number of options. Once you have been in any pension scheme for two years, you are entitled to the value of the contributions that were paid by you and your employer. The first option is to leave the €80,000 with your current pension scheme and simply let it accrue there. This might make sense if that scheme has low charges and the employer pays a lot of the administration costs. However, you may want to move the funds to a new employer's scheme depending on that scheme's rules. That might make sense if you want to try and keep all your pension funds in the one place.

Another option would be to transfer the money into a PRSA or a Personal Retirement Bond. These are both individual contracts between you and the pension provider.

Before deciding what to do, you should think about getting some independent financial advice to ensure you understand the costs that are likely to apply now and into the future - and how the funds will be invested.

You have done well in building up a significant fund at a relatively young age, so it is important to take the time to ensure that this fund is well invested. By doing so, your fund should continue to grow and not be subject to unnecessary ongoing charges.

Pros and cons of ARF

Q My father will be retiring shortly. He will get an annual pension of about €40,000 from a defined benefit pension scheme. He also has a separate pension pot of about €100,000 from a different job. He is considering putting that €100,000 into an Approved Retirement Fund (ARF). Would this be a good idea and what would be the pros - and cons - of doing so?

The options available to your father with his €100,000 pension pot will be to purchase an annuity where he will be paid a pension for life - or to transfer the fund to an ARF. Should he transfer the fund to an ARF, that would allow him to continue to invest that money and draw down on the funds as he needs them.

One thing you haven't mentioned is your father's option to take a tax-free lump sum. It might make sense to take most of this from his €100,000 pot and not from his defined-benefit scheme. When taking tax-free cash from a defined-benefit scheme, you are giving up some pension. Often, the value of the pension you are giving up is greater than the cash you will receive so it might make more sense to maximise the pension. As this is a quite complex area and any decisions will have an impact for the rest of your father's life, it would be worth his while to get independent financial advice before deciding what to do.

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