When it comes to your pension, think tax

Pensions are in a league of their own when it comes to tax-efficient investments – but that might not last forever. To maximise your tax benefits, you might like to act now.

This is because, as the push for auto-enrolment grows, so too do fears about marginal tax relief on pension contributions.

“It depends on how things pan out, but lots of things about auto-enrolment are not locked down,” says Trevor Booth of Mercer, who reckons higher earners might like to take advantage of the current advantages while they have them. “The tax relief could be eroded for personal contributions.”

To really maximise your tax benefits, push for more employer contributions while you are at it. “Employer contributions are not subject to PRSI and USC, so the bigger the employer contribution, the more tax-efficient it is, the better for you,” says Booth.

Tax relief plays a significant role in affording people the chance to fund their pension "but people need to be aware of how to maximise the tax relief available", says Eoghan Quigley of KPMG.

“The actual level of tax relief on pension contributions is restricted to certain limits and where you do not contribute the maximum amount for tax relief purposes on an annual basis, the balance does not roll forward to a year when you are in a healthier financial position – it’s a use-it-or-lose-it regime. One of the challenges individuals face is the competing demands that are placed on income at different points during a career and that it is not always possible for people to fund their pension on an annual basis.”

The maximum annual pension contribution allowable for tax relief purposes is calculated as a percentage of earnings (with a maximum earnings level of €115,000) and the percentage is set by reference to your age.

For example, an individual under 30 years can claim tax relief on contributions of up to 15 per cent of their earnings. This increases, with the maximum contribution percentage being 40 per cent for individuals aged 60 and over.

Maximum tax efficiency

Tax relief is granted at the marginal rate so for maximum tax efficiency you should contribute up to the point of receiving higher-rate relief only, currently 40 per cent. For example, where a 60-year-old earns more than €115,000 and contributes the maximum amount based on age, the maximum pension contribution for tax relief purposes is €46,000. For a higher-rate taxpayer, the tax relief is €18,400.

Certain sportspersons under the 50-years-of-age category are permitted to contribute at 30 per cent “This is welcome as it reflects the precarious nature of the occupation and the potentially stronger earnings level at different stages in a sportspersons career. However, for the rest of the pension population, the age-related limits are not aligned with the real costs of funding even a modest level of pension in retirement,” says Quigley.

“We have recently advocated to Government that the design of limits placed on tax relief for funding pensions should take a whole-of-working-life approach – supporting higher provision earlier in the working life if the taxpayer is in a position to fund, as well as in a ‘lumpy fashion’ throughout the working life as the individual’s financial resources and life stages allow.”

Self-employed people and entrepreneurs have additional considerations in relation to pensions. “The competing financial demands of funding the business are likely to mean that the entrepreneur begins to make their pension provision, or at least meaningful pension provision, at a later stage in their working life than an employee,” says Quigley.

As changes look to be on the way, now might be a good time to think pensions, suggests pensions expert Bernard Walsh at Bank of Ireland. "Take advantage of the tax relief while it's there. We are hearing talk of auto-enrolment tax reliefs – a figure of 25 per cent is being mentioned – which is something we hadn't heard a year ago. That compares with 40 per cent tax relief today. Will that 40 per cent always be there? There's a risk it won't," says Walsh.

Opportunities in life to avail of full tax relief are few and far between as it is. “A lot of people don’t realise that a pension is one of the few chances in life to avail of full tax relief. Most self-employed people address this at the end of each year, but a lot of employees don’t think about it at all,” says Gavan Ryan of Willis Towers Watson.

“They don’t know that if you are on, say €40,000 salary, and you contribute 5 per cent to your pension and your employer contributes 5 per cent, that 5 per cent costs you less than €100 a month but you are getting €330 worth of benefit. That’s a huge benefit and if you project that forward through a working life, it’s immense.”

Age restrictions on tax relief are quite restrictive. "The challenge that people have in their 20s, 30s and 40s is affordability – people just have so many demands on their money at that stage of their life that they can struggle to contribute," says Andrew Fahy of Investec.

“That catches people out on two fronts because not only do they struggle to catch up but they don’t get sufficient time to get the value of compounding and they hit tax relief limits on contributions. I’d argue that if someone hasn’t contributed in a particular year, they should have the ability to catch up at a later date, that ability to ‘flex it’,” he says.

But it’s important too not to be blinded by tax. “It needs to be all about what your retirement plan is – having a plan, revising it and getting good advice.”