Last week we had a look at the Covid Restricted Support Scheme [CRSS] In case you missed it Read here
Pensions, some people love them, and some people hate them. They are often very misunderstood. The purpose of this blog is to look at a pensions journey through your company. It will attempt to take out the complication so that you can understand the basics
I am a fan and have two pensions, one with Zurich and the other with New Ireland. Nothing major but I was lucky enough to be able to make small contributions to both over the last 15 years or so. I view them as a long-term savings plan with the extra benefit of tax relief. They come out of my account by monthly direct debit and are now part of my normal spending.
"Do not save what is left after spending, but spend what is left after saving" Warren Buffet
Company Pension Scheme - Start
You own all or part of your company. It is doing well and you are confident about the future of the business. You are on a good salary but have no pension. You decide to set one up. The company sets one up for you. This is an Executive pension scheme that the company contributes to but you are the effective owner. The company is making contributions to provide pension benefits to you, the executive. You do not make any contribution, so your net salary stays the same. This is a long-term savings plan, paid for by the company to benefit you. Some important things to note are
- The monies in your pension grow tax-free so the income that your pension earns doesn't suffer tax
- The company that pays the contributions gets a tax deduction for the payment, so they will save tax at 12.5%. There will be a higher percentage saving if a professional services company
- The company can make top-up special contributions to boost the pension fund. The company will get tax relief on this but may not get the relief all in one year
- You will have to make some investment decisions. In what assets will you invest pension monies. Riskier assets like property and shares perform better over time. But this will depend on the risk appetite and age of the pension investor.
- The aim is to build up as large a pension as possible. That means the earlier you start the better.
- If you die during service, the value of your pension will go to your Estate
What level of pension fund should I aim for?
The sweet spot is €800,000 which is a very large number. You could aim for more. It depends on when you start, investment performance, and the payments made. The reason for the €800,000 figure is that, at retirement, you can receive 25% of your pension fund tax-free, up to €200,000. Once the lump sum exceeds that number you will be paying tax on it. The rate of tax on a lump sum between €200,000 and €500,000 is 20%. If your final pension pot, at retirement, was €1,200,000 the lump sum would be €300,000.
|Net lump sum||€280,000|
With a pension pot of €800,000 after taking the lump-sum, there will be €600,000 left. What do you do with this? This is where it's important to understand some of the phrases around pensions
This is a pension product provided by pension companies that gives you a pension for the rest of your life. If you buy an annuity at 3% then the pension company will pay you €18,000 per annum for as long as you live. There are advantages and disadvantages to this. One advantage is that it gives you certainty of income. One disadvantage is that it is no longer your asset so if you die within a few years of retirement the pension dies too.
Approved Retirement Fund - ARF
Instead of purchasing an annuity, you can invest in an ARF with a pension company. The goal of this is that the ARF will pay you a level of pension while still maintaining its value, as much as possible. It would maintain its value through good investment performance. Say you retire at 67 then you will draw down 4% of the value of the fund. On €600,000 this is €24,000 of Income which is liable to tax.
The balance in the ARF is €576,000. The fund would have to grow by more than 4% to get back up to €600,000. If invested in cash this is very unlikely to happen
You can drawdown the full value of the ARF if you want. But you would pay a hell of a lot of tax!
The minimum rate of draw downs for ARF's are as follows
- Value less than €2 million - age less than 70 4%
- Value less than €2 million - 70 or more for the full tax year - 5%
- Value more than €2 million- in all cases - 6%
Approved Minimum Retirement Fund - AMRF
The reason for AMRF's is that you cannot draw down the capital until age 75 when an AMRF becomes an ARF. This is to protect the pensioner so that they don't spend all their money. If you do not have a guaranteed level of income of €12,700, when going the ARF route, then you will have to put €63,500 into an AMRF. Guaranteed income is the State pension or other pensions but not investment income. As the full state pension is now more than €12,700 many people have AMRF's that can convert to ARF's. It is possible to draw down the income from an AMRF. So, if the ARF grows from €63,500 to €66,000 the increase of €2,500 can be income for the pensioner.
Benny Watt is retiring from Watt Enterprises Ltd at 65. His pension pot is worth €700,000. He takes a tax-free lump sum of 25% which is €175,000. He has some choices with the balance of the fund. He can
- Buy an annuity - say at 3% which would give him an annual pension of €15,750 or
- Put the balance into an ARF. He can put it all into an ARF if he has a guaranteed income for life of €12,700. As he has no other pensions, he puts €461,500 into an ARF. He will take 4% of this as an income each year which will be €18,460 and
- Put €63,500 into an AMRF. He will access the state pension at 67. The AMRF can convert to an ARF when he gets that
- As an alternative to an AMRF he could use the €63,500 to buy an annuity
Benny aged 71
A few years have passed since Benny retired. He has a state pension of €13,000 per annum. The value of his ARF is €450,000. He doesn't have an AMRF anymore as that converted to an ARF at 67. At 71 he now takes 5% per annum each year as an income. This is €22,500 so his total income is €35,500. His wife Wilma is also in receipt of a state pension of €13,000, so combined income is €48,500. Remember he can take more income from his ARF should he wish. The tax rates are quite low on this
|Total Income €48,500||20%||€9,700|
|Less Tax Credits - Married, PAYE, Age||€7,090|
|Net Tax Liability||€2,610|
|USC - Benny only||€270|
|Effective Tax rate||5.94%|
Poor Benny gets a heart attack when he sees the price Wilma paid for her new shoes from BT. He doesn't survive. As the ARF is his pension asset it is part of his Estate. If he leaves the ARF to Wilma she won't pay any inheritance tax on it. If he leaves the ARF to his children, the taxes and tax liabilities depend on the ages of the children
- if the children are under 21 then they would be liable to inheritance tax but subject to thresholds
- if the children are over 21, which they are in Benny's case, there would be 30% Income tax payable
Benny, in his love for Wilma and to keep her in the style she's accustomed to, leaves all his Estate to her. 5 years later Wilma passes on to join Benny in a love nest in the sky! Wilma leaves the ARF to her two children Fred and Barney. As they are both over 21 the value of the ARF will be subject to 30% Income Tax.
The above is not investment advice. It is only to try and give some understanding of the pension journey for a company executive. To find out more about pensions click here Given low annuity rates the ARF option is more popular. You keep ownership of the asset so you will have to make some investment choices. This is all paid for by the company and should form part of a strategy to extract wealth from your company. Your accountant and advisers need to know what your long-term plan is. If they know you can work together in partnership to achieve those goals.
If you feel you could benefit from working with us give Deirdre a call on 051 396703 or contact us. If not ready yet, subscribe to our blogs and stay in touch.