Pensions are an excellent source of helping us ensure we are financially stable in retirement. They also a tax efficient way of saving as you receive tax relief on all of your pension contributions.
None of us enjoy handing over our hard-earned money to the taxman. The good news is, contributing to a pension can help you become more tax efficient.
The good new is the Government offer several tax incentives regarding pensions.
We will look at the other benefits of a pension in more detail further on. However, tax relief on pension contributions is one of the biggest advantages.
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How does tax relief work on pension contributions?
As you contribute to a pension, the net cost or ‘real’ cost is not as high as you think. The government provides tax relief at your highest rate to encourage us to save.
The higher your income tax bracket, the higher rate of tax relief you will receive. Therefore, if you are in the 40% tax bracket, you will receive 40% relief on your contributions.
Pension contributions tax relief example
Depending on your overall financial situation and goals for retirement, it is at your discretion as to how much you contribute to your pension.
How much you will need in retirement varies from person to person. Below we break down how pension contributions work in each tax bracket and calculate the net cost to you.
For simplicity, for every €100 you contribute, your take-home pay will only be reduced by €60 if you are in the 40% income bracket.
If you pay income tax at 20%, for every €100 you contribute the net cost will be €80.
| 20% Tax Bracket | 40% Tax Bracket | ||
| €100 | Total Investment Into Your Pension | €100 | |
| -€20 | Less Tax Saved | – €40 | |
| €80 | Net Cost To You | €60 | |
Above we see the ‘real’ cost of pension contributions. This will all be done by your payroll department and be deducted at the source.
However, the contributions are not unlimited and there are some thresholds in place.
Pension contributions limits
There are limits when it comes to the contributions to your pension while receiving tax relief. The limits directly correlate with your age.
As you get older, you have the opportunity to contribute a higher percentage of your earnings. It is worth noting that if you have more than one source of income, the tax relief is only in respect of the income from which the contributions are made.
| Age | Maximum percentage of taxable earnings allowable for tax relief on your pension contributions |
| Under 30 | 15% |
| 30-39 | 20% |
| 40-49 | 25% |
| 50-54 | 30% |
| 55-59 | 35% |
| 60 and over | 40% |
(source : Revenue)
Total earnings limit
There is a maximum limit of contributions that can be paid while claiming tax relief. The current limit is €115,000 per year.
Tax relief on pension contributions examples
Below we look at some different scenarios and illustrate how your age directly affects your ability to contribute and the tax benefits.
John | Age 32 | Pension contributions
| Name | John |
| Age | 32 |
| Salary | €40,000 |
| Max Contributions | €8,000 per annum |
As John is aged 32, he falls into a bracket that allows him to contribute a maximum of 20% of his earnings. This equates to €8,000 per annum.
Mary | Age 48 | Pension contributions
| Name | Mary |
| Age | 46 |
| Salary | €55,000 |
| Max Contributions | €13,750 per annum |
As Mary is aged 46, she falls into a bracket that allows her to contribute a maximum of 25% of her earnings. This equates to €13,750 per annum.
Peter | Age 53 | Pension contributions
| Name | Peter |
| Age | 53 |
| Salary | €61,000 |
| Max Contributions | €18,300 per annum |
As Peter is aged 53, he falls into a bracket that allows her to contribute a maximum of 25% of her earnings. This equates to €18,300 per annum.
Additional benefits of contributing to a pension
We have spoken about how tax relief on pension contributions is a major incentive. However, that is not the only benefit of having a pension.
Tax Relief
Tax-Free Growth
Tax-Free Lump Sum
The two other major benefits associated with having a pension are:
Tax-free growth
Another advantage is that once in a pension, your investment will grow tax-free. It will accumulate over time free of income tax, capital gains tax, or DIRT.
Avoiding all these taxes will save you a huge amount in the long run. As a self-employed person, any tax savings are always welcomed.
Tax-free Lump Sum
At retirement, you will often be eligible to take a percentage of your fund tax-free. The amount you take will be dependent on the type of arrangement you have and if you have taken lump sums from other pensions.
Most people will be eligible to take 25% tax-free as a lump sum. However, there is a limit of €200,000 that can be taken tax-free.
| Lump-Sum Amount | Tax Rate |
| Up to €200,000 | 0% |
| €200,0001 – €500,000 | 20% |
| Over €500.000 | Taxpayers marginal rate |
As we see in the table above, there are certain thresholds when it comes to taking your tax-free lump sum.
If you are considering accessing your pension it is always a good idea to consult an advisor.
Employer pension tax relief
As an employer, you will be entitled to tax relief on contributions made to a pension arrangement. These contributions will be deductible for corporate tax purposes up to certain limits.
Contributions paid by an employer to an occupational pension scheme are not treated as a benefit-in-kind and can be paid in addition to the contribution limits.
Contributions paid by an employer to PRSAs are treated as benefit-in-kind but income tax relief is provided subject to the overall contribution limits for employees.
You will be eligible to receive tax relief solely on your contributions alone.
Example of pension tax relief:
Eoghan pays income tax at a higher rate of 40%. Both Eoghan and his employer contribute equally to an occupational pension scheme. Contributions are €250 each per month.
| Monthly Contribution | Benefit in kind | Tax Relief | Net Cost | |
| Employer | €250 | €0 | €0 | €0 |
| Employee | €250 | €0 | €100 | €150 |
| Total | €500 | €150 |
Tax on an ARF/AMRF
As you approach retirement, you may start to look at your pension in more detail. You will likely have an Approved Minimum Retirement Fund (AMRF) and an Approved Retirement Fund (ARF).
These arrangements both have different rules regarding taxation and how funds can be withdrawn.
Tax-free Lump Sum
An AMRF is a plan that allows you to invest your pension after you have taken your retirement lump sum.
Any amount withdrawn from your AMRF is subject to income tax and USC.
As an ARF owner, you must also be aware of imputed distribution. Imputed distribution is a mandatory withdrawal of a particular percentage from your ARF.
Imputed distribution breakdown
| Age | Minimum withdrawal percentage per year |
| 61 | 4% |
| 71 | 5% |
It is important to note that where the total fund value is more than €2 million that withdrawals will be 6% from age 60 as per pension legislation.
Your imputed distribution withdrawal will be payable in December. It will be reduced by actual distributions or withdrawals you made throughout the year.
Lifetime limits on pension fund contributions
We all have a maximum lifetime limit on the amount of retirement benefits we can have. This is referred to as the Standard Fund Threshold (SFT).
The Standard Fund Threshold is the limit on the total capital value of pension benefits that an individual can draw from tax-relieved pension arrangements which come into payment for the first time after 7th December 2005.
The current Standard Fund Threshold is currently €2 million. If the aggregate value of your pension exceeds €2 million, it is possible to apply for a Personal Fund Threshold (PFT) in advance of your retirement.
The original Standard Fund Threshold was set at €5 million but was reduced to €2.3 million in 2011.
It was further reduced to €2 million in January 2014. If an individual has benefits which exceed a capital value of €2 million, the excess will be subject to 40% tax liability.
Exemptions may apply to individuals who have a Personal Fund Threshold Certificate.
How to Start a Pension in Ireland
Conclusion
We know pensions are beneficial for a multitude of reasons. Not only do they allow you to plan for retirement, they allow you to do it in a tax efficient manner.
You will receive tax relief on your contributions, tax-free growth and likely be eligible to withdraw 25% tax free at retirement.
The above certainly beats paying either 20% or 40% tax on your income and trying to save it in a deposit account.
If you currently have a pension, it is never a bad idea to have it reviewed. Many clients we help were initially unaware of the fees and charges associated with their pension. Following a review, savings can often be made.
If you are considering starting a pension, our team would be happy to help. We can discuss the tax benefits in more detail and find a plan best suited for your situation.
Feel free to book your complimentary consultation today.
Phone: 01 890 3518
| Phone: | 01 890 3518 |
| info@pensionsupportline.ie |
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*This blog should be used for information only and not taken as financial advice.
