Firstly, let’s look at the basic facts about self-employed pension funds for someone with a need to replace a relatively high income stream in retirement.
- The Standard Fund Threshold (sometimes referred to as the maximum fund) has been €2M since 2014
- The maximum salary allowable to qualify for personal tax relief in a given year is €115,000
- Using a joint life pension annuity at the point of retirement, with it set to increase at 1.5% each year, and with 2/3 payable to a surviving spouse, the potential rate of income is currently 2.72%
- People will typically take a tax free lump sum of 25%. For a fund at the maximum, this can be taken as €200,000 tax free and a further €300,000 at a tax of 20%.
- The residual fund in this case is €1.5M. If this was used to buy an annuity income stream it would amount to €40,800 per year, or 35.48% of the “allowed” salary of €115,000.
Of course, you could elect not to take the tax free lump etc., and use the full fund to purchase that pension income. In that scenario the pension payable would be €54,400 per annum, or 47.3% of the €115,000.
In other words, a self-employed person, who is limited in relation to the amount of tax relief they receive on contributions, is also limited as regards the income for which they can fund, limited to a pension income of 47.3% of (capped) earnings of €115,000.
Compare this with a similar public service person, retiring on a salary of €115,000 and full service. They would receive a pension of 50% (€57,500) AND a tax free lump sum of 1.5 times salary, (€172,500). Using the annuity rate above, this would equate to a fund of €2.29M. At its most basic, the self-employed are discriminated against, in this example, to the tune of some €290,000 – simply due to inequitable legislation.
What to do?
Every day I work with people who are either trying to save for retirement or who are trying to maximise what they have when they get to retirement. I have the following suggestions as to how the system should be urgently improved:
As a minimum step, The Standard Fund Threshold (maximum private pension figure) should be increased from €2M to €2.29M, to take account of falling annuity rates (down 23% since 2014 alone) and to level the playing pitch with public servants. It is also unfair that public sector pensions can avoid the Threshold, as there is no fund there. People who save are thus discriminated against.
The Threshold was introduced to stop the so-called “fat cat” pension. However, other measures, such as limiting tax free lump sums and capping the salary for claiming personal tax relief, have taken care of this. Falling bond and deposit yields have also meant very low returns for any conservatively managed pensions, creating a natural dampening down of pension fund values.
In order to level the playing field, an effective and simple solution is to remove the Threshold altogether and then to increase the imputed distribution figure from Approved Retirement Funds (ARFs) in retirement. Every ARF for someone over 60 is subject to an “imputed figure” of distribution, whether that figure is actually taken by the person as income or not. This way, the Revenue gets its tax take from the funds each year. Perhaps this should be changed to the following:
- Funds of up to €2M – imputed distribution of 4%, fully taxable
- Funds between €2M and €4M – 5%, fully taxable
- Funds between €4M and €6M – 6%, fully taxable
- Funds above €7M, 7%, fully taxable.
I am 75 years young and work full time, between holidays. There should not be any distinction as to what the imputed distribution should be for people of different ages (as it is currently), other than the distributions should commence when someone has “drawn down” their pensions from age 61.
The above solution would, I feel, simplify the whole regime. Research could, and should, be done to ensure that the exchequer does not suffer a loss of Revenue; if it did the above income distributions could be tweaked a bit. The changes would certainly make a more equitable system for the self-employed.
Dr. Dermot O’Mahoney
Director, City Life