It was good (for some) while it lasted but the Government has moved to close a loophole, which allowed company directors to significantly increase how much they could fund their pensions – and gain tax relief in the process.
Earlier this month, the Finance Bill, which now looks set to be enacted over the coming week due to an impending general election, introduced some notable changes to pensions. While the move to increase the standard fund threshold (SFT) – the upper limit on the size on pension fund availing of tax relief that a person can have – had been flagged well in advance, the decision to tighten up the funding of PRSAs may have caught some on the hop.
So, what are the changes and how will they impact (wealthy) pension savers?
PRSAs and business owners
Back in 2022, the Finance Act changed the rules so that employer contributions to a PRSA no longer triggered benefit in kind. In addition, no limit applied on the amount of employer contributions that could be made – up to the overall standard fund threshold for an individual of €2 million.
“The unrestricted funding model clearly put the PRSA at a competitive advantage compared to others,” says Fergal Roche, financial planning manager with Davy Private Clients.
Before this, once a contribution surpassed age-related limits – for example, 25 per cent of gross salary for people aged between 40 and 49 – the employee would be subject to BIK.
With employees still bound by the upper earnings limit for tax relief – €115,000 a year – the big benefit was for business owners, who were able to use the change to substantially boost their pension funding, gaining tax relief in the process.
Tony Delaney, chief executive of financial advisers Sys Financial, says it was “very valid” for the Government to bring in the change, as it offered an incentive for company owners/directors, who contribute to economic growth, to fund their pensions in a year in which they could afford it.
However, he concedes that it did lead to some “aggressive tax planning”. “They probably didn’t think it out enough,” he says of the Government’s decision.
[ The Irish Times view on raising the pension tax threshold: a retrograde moveOpens in new window ]
Revenue chairman Niall Cody told the Dáil in May this year that he was “concerned about some practices” under the new rules.
One example cited was a director of a company, who employed one of his children on the minimum wage, and then created a PRSA and funded it with €1 million. Or a wife could be hired on a salary of €5,000 and her pension bumped up.
While such practices may have been legitimate strictly in terms of how the legislation was worded, as Delaney notes, he says Revenue may not have considered such employments to be bona fide, and a director seeking to extract money tax efficiently from their companies in such a manner may have run into difficulties on this front.
Changes
This year’s Finance Bill includes a provision that, once enacted, means that employer contributions to PRSAs will be restricted to 100 per cent of an employee’s income drawn from the business in that same year. Anything over this will be subject to benefit in kind.
In effect, this means that a director drawing a salary of €100,000 will be able to match this with a pension fund contribution. Above that €100,000 limit, anything will be treated as benefit in kind and taxed in line with normal income tax rules.
As Roche adds, the new approach also operates on the basis of “use it or lose it”. Business owners who cannot afford to fund their pension in one year will not be able to back-fund their retirement fund and will lose out on eligible tax relief for the year in question.
[ In your 30s? It’s time to get serious about your pensionOpens in new window ]
It is undoubtedly a sharp reduction on the benefit that was previously in place but, as Delaney notes, it is still “very attractive” compared with what an employee is entitled to.
It will, however, likely spur a move away from PRSAs for many business owners. “This is likely to curtail the use of PRSAs as the pension structure of choice for some individuals, particularly business owners,” says Roche.
What to do?
Given the impending restriction, some business owners may rush to bump up their pension now before the Bill is enacted. But, says Roche, it’s not the only choice.
“There are solutions out there which should be able to deliver the same outcome, with a few tweaks,” he says, citing a master trust, which generally allows for a much larger contribution from business owners than other pension products.
“It could be very significant again,” he says, adding that it will “definitely allow more than 100 per cent [of salary]”.
It won’t, however, allow for uses that run counter to the spirit of the rules, as happened with the unrestricted funding of PRSAs.
“With the new rules in the PRSA, it won’t allow substantial contributions for those on low salaries,” says Roche. Under a master trust structure, the further away from retirement you are, the lower the amount you can put in.
Standard fund threshold
It wasn’t the only change in the budget. Amid strong lobbying from interested parties claiming that top public sector jobs were no longer viable unless the pension cap was removed, changes were set out to the standard fund threshold (SFT).
Until now, this threshold limited tax-relieved pension savings to €2 million. Once a person’s pension fund went past this figure, they were charged tax, at 40 per cent, on the excess. According to Delaney, this resulted in a “penal” effective tax rate of 72 per cent on anything above this as you were taxed again at the marginal rate when the pension income was drawn down.
Of course, some would argue that it is a lucky few who get to worry about this penal tax, given the average Irish pension fund has just about €100,000 in it. As Delaney notes, opting to change the exit tax regime – which wasn’t done but which has been mooted in the since published Report of the Funds Sector 2030 – would have benefited a lot more people than changes to the SFT.
[ What income does a €100,000 pension pot give you?Opens in new window ]
In any case, the SFT is now set to rise to €2.8 million by 2029, and on an annual basis thereafter in line with increases in earnings. As Roche notes, given the impact of wage inflation, “it could be above €3 million in 2030″.
For Delaney, this is a “very positive” decision. However, the tax on the chargeable excess tax will remain at 40 per cent – pending a review by 2030. “It would have been great to see them reduce that,” he says, citing a possible fair figure of 20 per cent.
“I’d be very happy paying 20 per cent on something that had grown tax free for me,” he says.
For those who may still be at risk of the excess tax, Delaney advises that “it’s how you draw down the benefits that will be absolutely crucial”. He notes that someone in poor health, who didn’t need to draw down their pension, could end up paying this out tax free to their spouse in the event of their death.
- Sign up for Business push alerts and have the best news, analysis and comment delivered directly to your phone
- Find The Irish Times on WhatsApp and stay up to date
- Our Inside Business podcast is published weekly – Find the latest episode here
