For many entrepreneurs a pension is almost the last thing they are thinking about when they are starting up and growing their businesses. Most of their time, energy and financial resources are consumed by the business in those early years. That leaves many of them with a veritable mountain to climb by the time they have the spare cash to invest in their pension, which may be when they are in their mid-40s or even later.
The good news is that they do have options now that their company is generating enough cash to pay into a pension, even if one of the more traditional routes has effectively been closed off.
That route was the Small Self Administered Pension Scheme (SSAPS). Essentially a one-person scheme, it allowed members a high degree of control over investments and they could even buy properties through it. However, the implementation of the Institutions for Occupational Retirement Provision (IORP II) Directive has more or less put an end to them due to greatly increased governance and other requirements.
The new favoured option is a product that has been around for a long time but never really captured the imagination – until now. The Personal Retirement Savings Account (PRSA) was originally created to offer a pension option to self-employed individuals and others not covered by occupational schemes but it is now coming into its own for business owners.
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“There are still options available to fund for retirement and extract wealth from the business,” says Gavin Moran, head of wealth management at WTW. “There are two main options you can use, a company-sponsored PRSA or a Retail Master Trust. For those individuals already in a SSAPS, they will be obliged to move into one of these vehicles by April of 2026, when the derogation period ends.”
He explains that the Finance Act 2022 introduced changes to PRSA legislation which mean there is no upper limit on the level of contribution someone can contribute to their PRSA. “However, from a practical point of view, there is a lifetime limit known as a Standard Fund Threshold (SFT) of €2 million and if the aggregate of all of your pension funds exceed this amount when you come to crystallise them, a very penal Chargeable Excess Tax applies.”
There are also generous limits available with the Retail Master Trust but this requires a calculation as to your salary, length of service and time to retirement, Moran says.
“There is no such calculation required with a company-sponsored PRSA,” he adds. “A Retail Master Trust does have some advantages as, depending on your circumstances, there may be more favourable lump-sum options available. This option also offers better protection from creditors. You should speak to a certified financial planner or financial adviser in order to ensure that you are taking out the most suitable option for your circumstances.”
“Employers are able to pay unlimited BIK-free contributions to a PRSA for an employee or director,” explains Ashling O’Neill, certified financial planner with Clear Financial. “The contributions are not limited by the previous salary, service or revenue age-related tax relief contribution limits, which means there is an opportunity for business owners to boost up their benefits without age-related limits, while still considering the overall standard fund threshold of €2 million.”
How the money is paid into the pension matters from a tax perspective. An investment in a pension offers one of the few tax breaks still available. Company contributions are not treated as a benefit in kind (BIK); personal contributions receive tax relief at your marginal rate of income tax; the funds grow within the pension fund tax free; and there is a tax-efficient lump sum available at retirement.
“For a company owner, it is more tax effective for the company to make the pension contribution rather than personally, as they will avoid the PRSI and USC on such contributions,” says Moran.
Bank of Ireland head of pensions and investments Bernard Walsh believes the tax advantages should be front of mind when considering a pension. “There are so few tax breaks open to people today,” he says. “In the past there was the possibility of investing in property in tax-designated areas but that is not there any more. The only ones left are things like film finance and the Employment Incentive Investment Scheme and these can be quite complex.”
The other key consideration for late starters is their risk appetite. The closer they are to retirement the greater the potential impact of market volatility on their pension pot. As they say in the investment world, it is not a question of timing the market, it’s time in the market that counts.
“Let’s assume the person is 55 and plans to retire at 65,” says Walsh. “There are strategies that employ what is known as a lifestying approach in the run-up to retirement. They de-risk the investments. But if you are planning to invest in an Approved Retirement Fund (ARF) for another 20 years or more why de-risk when you are going to be re-risking when you retire?”
One aspect of de-risking is connected to tax-free cash. “You could de-risk the portion of the money you are intending to take as a tax-free lump sum,” Walsh explains. “If you have €500,000 in the fund and are hoping to take 25 per cent tax free, you might de-risk €125,000 over that period to preserve its value. You could adopt a different strategy for the remainder which will continue to be invested for the next 20 or 30 years.”
Risk varies depending on individual circumstances, says O’Neill. “Everyone is totally different when it comes to risk,” she adds. “People should always seek to have a diversified fund and look at their short, medium and long-term needs. If you are 30 you may be able to afford to take more risk as you are probably not planning to use the money for at least 30 years. On the other hand, if you are a 60-year-old company owner who is planning to take a large lump sum on retirement you need to take a different view. You could safeguard that portion of your fund by keeping it in cash when you are a year or two from retirement.”
She recommends a blended approach for investment of the remainder of the fund when in retirement. “When they reach retirement, a lot of people think they are done with risk. Over the past number of years people haven’t had to deal with inflation in retirement. It’s harder for people to make their money work for them now.”
For most people, the ARF is the vehicle which they will use to make their money work. An ARF is an investment fund which people use to generate returns which they hope will meet at least some of their needs in retirement.
Under a rule introduced in the wake of the financial crash, ARF holders are taxed annually on a notional drawdown of 4 per cent of the value of the fund whether they take it or not. Most people take that 4 per cent or more and they also need to take inflation into account when it comes to preserving the overall value of the fund. But the potential returns from the fund are, like any other investment, related to the amount of risk the individual is willing to take.
“If your money is invested in relatively low-risk fund returning 2 to 3 per cent, you run the risk of your money running out over time,” says O’Neill. “You need to get at least enough to preserve the value of your fund.
“When we are advising clients, we break down how much income they will need from their retirement in the next five to seven years. That allows us to gauge how much of their fund needs to be in lower-risk funds to reduce risk for their short-term needs, and you normally take your income from this portion of your fund through your retirement fund. We then look at monies they won’t be using over the next seven years or so and we review and compare appropriate investments for that. We can look at medium-higher risk funds that will be able to give your money the opportunity to preserve your wealth.”
She recommends reviewing the investments every few years. “It is vitally important to have a good financial planner who works directly with you to rebalance your pension investments throughout your retirement.”
In the end, it comes down to individual circumstances, according to Moran. “There is no one size fits all and the level of investment risk will depend on not alone their tolerance for investment risk but their own personal circumstances – the time left to retirement, whether the end goal is a lump sum, an annuity or an ARF, whether they are in a position to delay the crystallisation of their pension funds for a little while if a downturn arrived, other assets that they may hold personally and so on.”