High earners with pension pots that are close to breaching a €2 million threshold that trigger a punitive tax regime should not rush to avoid hitting that cap just yet, top accountancy firm and consultants PwC have advised.
The cap on pension savings subject to tax relief was introduced in 2005, originally at €5 million. That was cut after the financial crash to €2.3 million in 2010 and then to €2 million in 2014 with the threshold sitting unchanged since then.
Any amounts in excess of the €2 million limit are immediately subject to tax at a rate of 40 per cent. The subsequent pension income received is then subject to further deductions for income tax, USC and (possibly) PRSI in line with normal practice. This means the effective rate of tax can be more than 70 per cent for pension assets that exceed the fund threshold.
PwC notes that average pay has increased significantly over the past decade and pension fund assets have also grown strongly as stock markets enjoyed a bull run. On the flip side, the impact of inflation over the period has reduced the buying power of a pension fund over that time.
“The standard fund threshold tax is penal where pension assets exceed €2 million,” PwC pensions partner Munro O’Dwyer says.
“Tax policy supports the making of pension contributions. However, for impacted individuals, the standard fund threshold limit is counterproductive. There is an imperative to review the limit to take account of inflation.”
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Even adjusting purely for average salary growth, Mr O’Dwyer says the standard fund threshold would now stand at about €2.63 million.
“Initially, the tax served the purpose of discouraging excessive pension funding,” he says. But “as limits were not revised to keep pace with inflation, there have been a number of unintended consequences, and today the limits are impacting on a cohort of pension savers who were arguably never the intended targets of the initial legislation.”
Thousands of senior executives are now at risk of breaching the upper limit on Irish pension fund savings, leaving themselves open to punitive tax on those savings, PwC says.
However, PwC is advising clients to hold off on any radical decisions on their pension pots – such as tapping them earlier than planned to keep them below the limit – pending the outcome of an ongoing review by Government of the standard fund threshold.
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“There is legitimate potential for upside out the review,” Mr O’Dwyer said, with some reform expected to be announced in the October budget.
PwC says expectations are high that the threshold might be index-linked going forward. “No one is trying to damp down expectations,” he added, pointing to the Government’s recent pre-budget Tax Strategy Group papers.
“A rise in the actual threshold at this time would be a real bonus and very much may happen,” he said.
A separate survey by the Independent Trustee Company has found that most people are totally unaware of the threshold and how it might leave them facing a large and unexpected tax bill close to retirement.
The ITC survey of more than 160 financial advisers also found that 71 per cent feel the Government should reduce the 40 per cent tax rate levied on anything above the current €2 million threshold. Most argue imposing the standard income tax rate of 20 per cent would be fairer with the rest suggesting a 33 per cent rate.
“The sense among respondents is that people should be rewarded, rather than penalised, for saving well for their retirement,” Glenn Gaughran, head of business development at ITC, said.
“This used to just affect the top person in an organisation but it is no longer just the most senior people,” said Mr O’Dwyer. “This is no longer a minority sport.”
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