Are pensions only good for tax breaks?
I think it’s true to say at this stage that most people are aware at some level of the significant tax benefits of pension planning. However, apart from obviously securing your lifestyle in retirement, are the tax benefits the only reason that pensions are good for you, or are there other reasons to start or continue your pension planning?
Quick recap of the tax benefits
The tax benefits of pension planning are significant and except for high earners, have been left relatively untouched. The main benefits (within certain limits) are;
- Full tax relief available at your marginal rate on contributions
- Your fund grows free of tax (no DIRT, CGT etc.)
- A portion of your fund can be taken tax free at retirement
- A structure can be put in place at retirement (Approved Retirement Fund – ARF), which enables tax efficient wealth transfer to your estate on death with any remaining fund.
However there are many other factors that make pension planning very attractive. Here are a few factors that increase the need for pensions, followed by an opportunity that is available to many self-employed individuals and company directors that passes some people by.
Life expectancy has been increasing steadily in Ireland and is now 78 years for males and 82 for females. While this is undoubtedly good news, unfortunately it means that we will all need a bigger nest egg to see us through our golden years. More and more people will now be retired for 25-30 years. What size pension fund would you need to maintain your lifestyle for that period? Many people seriously under-estimate the size of their required fund to maintain a chosen lifestyle over such a long period of time.
State pension rates not increasing
Unfortunately long gone are the days when the annual budget heralded a small increase in the state contributory pension in line with inflation. In fact there hasn’t been an increase since 2009, with it currently stubbornly stuck at €230 per week and little prospect of an increase coming any time soon… Indeed in recent budgets, we saw a further whittling away of benefits enjoyed by pensioners, with more restricted access to medical cards and the removal of the phone allowance etc. This basically devalues the pension every year, making it even more important for people to carry out their own retirement planning.
Waiting longer for the State pension
One of the cutbacks in recent years, which received little attention, was the pushing out of the State pension age from 65 to 68, in instalments. The first cut happened in January 2014 – since then individuals have to be aged at least 66 to qualify for the Pension. From now on it increases in instalments to 68, depending on when you were born. The bottom line is that if you were born after 1960, the changes in comparison to pre-2014 mean that you have lost out on 3 years State Pension (say about €36,000 in today’s terms) or 2 years (say about €24,000) if you’re self employed. So if you are still planning on retiring at age 65 or before, you will have to fund for this lack of state benefits for these years yourself. A pension plan is probably the most appropriate and tax efficient way to do so.
And now for that opportunity!
Employing your spouse and gaining valuable tax and pension benefits
If you work for yourself but your spouse currently doesn’t work in the business, it may make financial sense for him or her to get involved in the business. There are a number of tax and pension planning advantages in your spouse working in your business in return for a taxable income:
- As a married couple with two incomes, up to €67,600 of taxable income is subject to standard rate tax, but the limit for a married couple with one income is just €42,800. This means more of your total income is taxed at a lower rate if you are both working.
- If you’re in a partnership or your business is a company, your spouse’s employment by your business may be insurable for PRSI purposes, which means he or she may qualify for a State Pension, or for a higher pension, in their own right in respect to these additional PRSI contributions.
- The business may be able to set up an employer pension arrangement for him or her, and any contributions the business pays into it will be tax deductible as a business expense, within certain limits, without causing a Benefit in Kind for your spouse. Some or all of this retirement fund could be taken tax free by your spouse when he or she retires, subject to certain restrictions.
The Need for Advice
These are just a few thoughts on the value of pensions, over and above the much heralded tax benefits. Pensions are a very complex area, unnecessarily so in our opinion! As a result, it is our job as an adviser to clarify and find the right solution for clients. Please give us a call to help us find the right pension solution for you.