Washing away the DIRT

AS THE EURO ZONE crisis rumbles on, an indication of just how mixed up things are in the banking market is that investors are favouring lower yielding alternatives to the tax-free savings options offered by An Post on the grounds that they are more secure.

“In our experience, investors are slightly more concerned regarding the security of An Post products, and this is getting more focus than the tax advantage they offer,” notes Vincent Digby, principal adviser with Impartial, adding, “the sequence of priorities tends to be security, liquidity and to a lesser extent return”.

Indeed An Post is not included in the Deposit Guarantee Scheme, which covers €100,000 in savings per individual per institution. Instead, the security of its deposits is reliant on the solvency of the State. In this regard, just like Government, bond holders are expecting to be paid a premium for holding Irish government debt, so too are savers with An Post.

And, given the recent rise in Deposit Interest Retention Tax (DIRT) to 30 per cent at the start of this year, if you’re looking for the best return, An Post’s tax-free options have become even more attractive. After all, at a rate of 30 per cent, DIRT will eat away at interest earned on your savings by the order of €30 on every €100 you earn in interest.

“It still has a place. It’s very attractive from a net return perspective, and a very worthwhile and valid option to consider,” notes Digby.

There are a number of DIRT-free options available to Irish savers, with An Post the main provider. It has a number of products aimed at either a lump-sum or regular savings, and offers a rate varying from 3.23 per cent to 3.53 per cent AER, depending on the term of the account. It is important to note however, that not all of An Post’s products are DIRT free, so check before you invest.

Another option is a special term account, although the returns on these tend to be lower than those offered by An Post. Available from providers such as credit unions, AIB and Bank of Ireland, these are deposit accounts that have a set term and offer DIRT-free savings on the first €480 in interest earned annually on a medium-term account, and €635 on the long-term account.

For example, AIB’s special term account can be opened for amounts ranging from €6,000-€25,000 and for terms from three to five years. It is currently paying interest of 2 per cent AER on its three-year account, and 2.5 per cent on the five year option.

Finally, if you’re feeling patriotic – or just looking for a decent return – you could consider the NTMA’s National Solidarity Bond.

When first launched, the bond was criticised for requiring investors to stick with it for the full 10-year period in order to get the maximum return, but it does offer a decent return.

Moreover, a four-year option is also available. While the annual one per cent interest payment is liable to tax, the final lump-sum bonus (40 per cent on 10-year bond; 11 per cent on four-year bond) is tax-free.

While it may seem a no-brainer to choose a DIRT-free savings option if you’re looking to maximise your return, as the banking crisis rumbles on, financial institutions are continuing to pay over-the odds for deposits in an effort to shore up their balance sheets. So is the DIRT-free option always the wisest?

Take a lump-sum of €10,000, invested at 3.53 per cent in a DIRT-free product. In its first year, it will earn €353 in interest, with no DIRT deduction. A comparable regular savings account on the other hand, will only return €247.1 after year one once DIRT is deducted, indicating a lower effective interest rate of just 2.47 per cent. In such a scenario, the obvious choice is to plump for a DIRT-free option.

What about some of the market-leading rates out there at the moment? EBS for example, has a rate of 4.26 per cent AER (5.35 per cent over the full 15-month term). Based on the return over a year, this account would generate interest of some €426 – however, when DIRT of €127.80 is deducted, the return slumps to €298. So the DIRT-free option wins again.

Indeed if you’re looking to match An Post’s tax-free rate of 3.53 per cent, you would need to find a savings account paying about 5 per cent in interest.

When it comes to regular savings, the DIRT-free option is again the most attractive. With An Post, you can expect to earn 3.37 per cent on savings of between €25 and €1,000 a month. With EBS on the other hand, you can earn 4.25 per cent on amounts of between €100 and €1,000 a month. So which is the better option? An Post once more.

However, where normal DIRT-incurring accounts can be more attractive is their relative liquidity. For example, the best rate from An Post requires you to lock away your funds for five-and-half-years, while the shortest term from either An Post or a special term account, is three years. EBS on the other hand, pays one of its best rates over a 15-month term, while you can get an instant access account with Nationwide UK, which pays 3 per cent in interest.

Moreover, An Post’s regular savings need to be locked away for the full five-year term to earn the interest tax free. Given the current economic uncertainty, having ready access to your cash is very important for some.

As previously mentioned, other institutions operating in Ireland – both domestic and foreign – are likely to be covered by the €100,000 guarantee scheme.

Of course for some people, DIRT isn’t an issue, as a number of exemptions apply. If you are over-65 and have income of less than €18,000 a year, or €36,000 for a married couple; or your tax liability is below your tax credits for the year, you can apply to Revenue to either get a refund on DIRT paid, or to stop it being deducted at source. Similarly, if you are permanently incapacitated, you may be eligible to be exempt from DIRT.

While DIRT is deducted at source from financial institutions in Ireland, you are entitled to be given a statement from your financial services provider of the amount of DIRT deducted from your interest, so it may do no harm to check this from time to time, to ensure its accuracy. Moreover, if you regularly file a tax return, remember to include any interest you have earned – you won’t have to pay any further tax on the interest but it needs to be declared.

If you are one of those people who have invested in accounts in northern Ireland or further afield like Germany or Switzerland due to the euro zone crisis, you may need to pay further attention to DIRT.

“You need to be mindful of the fact that, just because you’re investing money abroad doesn’t mean it’s not liable to Irish tax,” notes Beryl Power, a senior tax manager with PWC. Typically, deposit interest is only taxable in the country of residence.

For savings accounts within the EU, DIRT is liable at a rate of 30 per cent – but outside the EU it is liable at your marginal rate. Remember, if you have savings abroad, you need to declare any interest earned via an income tax form (Form 11). And given the lessons learned from the recent State pensions debacle, it’s worth noting that this form needs to be filed whether you’re a PAYE worker or not.

According to the Revenue Commissioners, you must return details of a foreign bank account on Form 11 in the year in which the account is opened. Thereafter, everyone – even PAYE employees – must declare the foreign deposit interest paid or credited to the account on Form 12 (Return of Income, Charges and Capital Gains). Remember, if you don’t meet the appropriate filing dates, then even EU-sourced deposit interest will be liable to tax at your marginal rate.

If you are considering putting some savings abroad, Digby warns against it. “Our view is that if you’re coming to this issue from a capital preservation agenda, then we don’t tend to recommend foreign currency. It has a speculative element which could go in your favour or against you – and you could lose 10-15 per cent of your capital.”

Similarly, Power cautions clients to consider the inheritance tax implications when placing money abroad, in case of death.

“If you’re putting money into an account in a foreign country it is exposed to foreign inheritance tax, and rates in Europe can be much higher than in Ireland (30 per cent),” she warns.