No change to tax relief on pensions for ‘squeezed middle’

Despite a number of small changes to the tax treatment of pensions over the last few years, they remain one of the most tax-efficient ways to save for retirement.

There was, however, strong speculation not so long ago that the marginal rate tax relief on pension contributions would be scrapped in favour of a single 33 per cent rate, or worse reduced to 20 per cent, like medical expenses relief.

“Income tax relief at 41 per cent is still in place and is one of the very few remaining highly valuable reliefs available to the ‘squeezed middle’,” said Jim Connolly, head of pensions at Standard Life.

“I suspect many people read the headlines of three to four years ago that pension tax relief was going to be halved and therefore didn’t make sense, and don’t realise it never happened.”

The marginal rate tax relief seems destined to stay, according to Connolly.

“We believe politicians and policy-makers understand that private provisioning of pensions requires a lot of saving, and higher rate income tax relief is a must towards saving an adequate pot,” he explained.

“If you do not have the privilege of a public sector pension, you need all the help you can get. If Fine Gael or Labour tried to lower income tax relief having implemented property tax and water charges, the likelihood is that middle classes would make their severe dissatisfaction known in the 2016 election.”

Joyce Brennan, senior retirement consultant at Mercer, adds that although savers no longer receive contribution relief against PRSI or the Universal Social Charge (USC) while employers cannot avail of PRSI relief any more, this doesn’t detract from the value of the income tax break.

However, it is clear that any new tax moves against pensions would be hugely unpopular. It is estimated that the Government has reaped €2 billion alone from the levy on private pensions since 2011, the rate of which rose from 0.6 per cent to 0.75 per cent from 2014, while a rate of 0.15 per cent will apply in 2015.

“Pension scheme members and sponsoring employers have made a significant contribution to closing the budgetary deficit, and we believe no further tax burden should be placed on them,” said Brennan.

One of the small changes to pension tax breaks was the cap on tax-free lump sums at €200,000, with the balance to €575,000 taxed at 20 per cent. Furthermore, anyone whose final pension fund value exceeds the standard fund threshold of €2 million (previously €2.3 million) will be taxed at 41 per centon amounts over this new-ish limit.

Needless to say, the impact of the threshold change has been limited to high-income earners. “The reduction in the threshold only affects a small population of the workforce,” said Connolly. “For the rest of us it is seen as an endorsement of the tax efficiency of the pension structure. Basically, Revenue are saying that they will allow someone to accrue a fund of €2 million tax efficiently, but beyond that they will be penalised.”

'Very fluid'
ARF rules

Additional retirement funds (ARFs) have become more widely available but the rules regarding access seem to constantly change, experts say.

ARFs allow the newly retired the option of continuing to invest some of their pension fund as a lump sum rather than spend it all on an annuity.

Jim Connolly, head of pensions at Standard Life, explains that ARFs are popular now because annuity rates are very low, so they offer retirees the option of postponing buying one.
You do have to draw down at least 5 per cent of your ARF every year as a minimum, however. "They are compelled to draw down 5 per cent but they could draw out 100 per cent if they wanted," he said. "The key here is that the individual has the choice."

However, he added that ARF rules are “very fluid” and changed regularly by Revenue. In 2011, the rules regarding the minimum income retirees under the age of 75 needed to have before they could invest in an ARF were changed. Before 2011, if you did not have an income of at least ¤12,700 a year, you had to set aside ¤63,500 to put into an AMRF (Approved Minimum Retirement Fund) that you were not allowed to touch until you turned 75. The minimum income requirement rose in 2011 to ¤18,000 a year, while the amount you needed to put into an AMRF rose to 119,800.

However, these rules were relaxed in 2013 but are set to return in 2016. Why?

“The cynical rumour is that they [Revenue] wanted to get their little paws on the tax that the 5 per cent forced withdrawal produces,” said Connolly.

He said the requirement to ringfence ¤63,500 of your ARF investment is the Revenue’s “safety rule to prevent you blowing your entire fund”, but raising this minimum amount to €119,800 meant that retirees had less to draw down from their funds as taxable income, which may explain the decision to temporarily revert back to the pre-2011 rules.