Pension planning is one of those issues that can be left on the to do list! And often when we as Advisers recommend Pensions, there are genuine concerns in relation to the tax efficiency of pension savings.

Tax relief on pensions is often a contentious issue. One of the main arguments against actually contributing to pensions in order to fund a retirement pot as such is the perception that whilst tax relief if available on entry, effectively one is taxed highly when taking pension benefits.

I would like to look at this in a little more detail today. Firstly we will recap on the tax relief’s available.

Simply put, pension tax relief makes it more attractive to save for your retirement by giving you generous tax breaks on the money you invest in your pension. Essentially, your tax relief is provided in three phases;
•Tax relief on contributions
•Tax relief on investment return
•Tax free lump sum at retirement

Therefore as a higher rate tax payer if you contribute €100 to your pension, due to tax relief available of 41%, it costs you only €59.

If you put a Single Premium of €10,000 into your pension, as a higher rate tax payer the net cost to you after tax relief is €6,000! If you were to invest the sum of €6,000 into your pension, you would achieve this instantly!

If we consider this for a moment; if we invested the sum of €6,000 – how long do you think it would take this sum to grow to the sum of €10,000? The answer is that if we assume a net return of 2.25% compounded return, it would take 21 years!

This is a startling reminder of the power of pension planning and the tax efficiency of same; not only are you planning your future you are doing so in an extremely tax efficient manner and making your hard earned money work for you!

As already mentioned however, there remains a strong perception that tax on benefits is high and overrids the benefit of tax relief on entry.

This is simply not the case. If we look at the below table we can clearly see the expected tax treatment on benefits assuming a married/civil partnership over the age of 65.

 

Total Income​

Effective Income Tax Rate​

€36,000​

Zero​

€40,000​

4%​

€50,000​

11.2%​

€60,000​

16%​

€70,000​

19.45%​

Notes:

  • Please note the information and tax rates applied above are based on Irish Life’s understanding of legislation and Revenue practice as at January 2018 and may change in the future.
  • PRSI and USC may apply, although there is no PRSI liability from age 66​
  • Max USC rate for over 70s is 2% if total income less than €60K or medical card holder.​
  • Future tax rates may be different​

Therefore, we can see that the myth around a large portion of your retirement fund ultimately being taxed at a high rate of tax is simply not the case.  Moreover once we factor the tax relief available on making the contributions and the effective rate of tax on maturity, we cannot ignore the fact that ultimately pensions are an excellent, tax efficient savings tool.

 

This is an opinion only and does not constitute advice as individual circumstances will determine all financial advise given.If you want to discuss this please contact us.