Watching the funding threshold

The Standard Fund Threshold is a cut-off point in Irish pensions which is really a testament to the tax efficiency of pensions as a savings vehicle. It allows high earners to accumulate up to €2 million, but that’s it. The threshold represents the maximum that any individual can hold in (pre-retirement) pension funds before being subject to an effective tax rate of around 72 per cent.

In terms of disclosure there is an obligation on the individual to inform Revenue. They must complete a declaration, disclosing all other pension assets they have. This arms their current administrator with the details they need to assess that individual’s position against the threshold.

Jim Connolly is head of retirement planning with AIB. He points out that anyone who has a pension expectation of about €60,000 will be knocking on the door of the threshold. Given that public servants get a pension of 50 per cent, any public servant on a salary around €120,000 would likely reach it too.

“The idea of a pension threshold was first introduced in 2005 to deal with some tax arbitrage, where some prominent individuals used the former pension rules to accumulate tens of millions in pension assets. The original threshold was set at €5 million and has since reduced to €2 million,” Connolly says.

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“If someone reaches retirement and exceeds the threshold even by €1 the pension administrator will immediately take 40 per cent chargeable excess tax and remit that to Revenue. The balance of 60 cents will itself be subject to PAYE, incurring another 52 per cent in taxes. All in all, any excess over the threshold suffers an effective tax rate of about 72 per cent.”

Ian Reidy, financial planning manager for RBC Brewin Dolphin, points out that the threshold in the UK is now down to €1 million making the Irish threshold still very generous.

In terms of how this pension is accumulated, Reidy points out that two factors contribute to the size of someone’s pension.

“One factor is the cumulative amount of pension contributions that go into the fund. If you are in an occupational scheme, those contributions will come from your employer, and in most cases, the employee as well. Or if it’s just a personal pension those contributions only come from yourself.

“The second factor is down to the investment returns. If a pension is invested in the markets over the long time with the compounding effect of returns, employees who have high salary and generous contributions from their employer can find themselves either at or close to this €2 million threshold often several years before the expected retirement age. And that poses a problem for them,” says Reidy.

Connolly says: “There is a lot of planning that can be done to improve someone’s position if the threshold is an issue, but this can be difficult for people whose pension has hit the threshold before they’re ready to retire.

“For others, some individuals can retire early, redirect pension contributions to salary (52% is better than 72%), dial down their investment risk to manage the glidepath of the fund towards the threshold, and others can choose to not retire at all and aim to pass the benefit as a death benefit,” he says

“This is very clearly when people need to seek out professional advice,” agrees Reidy. “In our experience there’s certainly no obligation on the employer to notify somebody that they are over the threshold. If somebody finds themselves at say age 53 about to hit that threshold, then an employer isn’t responsible for this excess.

“Options in this case include ceasing contributions into the pension scheme. Alternatively, they might consider lowering the risk level within the pension, thereby dampening down on the investment returns. Another consideration is if the person can retire at a younger age. Can they crystalise the value and remove the issue of exceeding the €2 million threshold?”

Reidy suggests it would make sense to talk to the employer about possibly switching the pension contribution back into salary, thereby reducing the tax implications. He argues that a conversation with the employer can look at different options.

There are other tax efficient saving schemes that might also be explored such as the Employment and Investment Incentive Scheme (EIIS) which had replaced the BES programme. In the EIIS tax relief is available at the investor’s highest rate of income tax and the investments made into companies engaged in certain manufacturing, services, tourism, R&D, plant cultivation activities, construction, the leasing of advance factories or in certain music recording activities.

“However, these are complex investing options, and I would argue that anyone looking at alternative investments should seek out professional advice and support where the pros and cons may be considered,” says Reidy.

There are also considerations where the death of the individual will impact the family financial circumstances.

“It’s a great conversation to have with an adviser which can allow the individual to make an informed decision on what is best for them and for their family. This is often a blind spot for people who do not consider what happens to their pension when they die. This conversation will help them mitigate the possible financial risk that is not only good for them, but good for their family in that sad situation.”

Planning is everything according to Reidy. He points out that an occupational pension scheme allows the pension owner to withdraw four times their salary as a lump sum and up until last year the remainder would have to be used to buy an annuity, which wasn’t great with the then low interest rates.

“My advice is to consider what happens to your pension fund for your spouse. If you like an alternative outcome, that alternative outcome being the full value of your pension going tax free to your spouse, then talk to an adviser.”

Overall, Reidy doesn’t necessarily see the punitive nature of the threshold. “If you are approaching that limit then it means you are going to have a comfortable pension regardless. It’s a nice problem to have.”