Tax Free Investments
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mandelbrot
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Why is "tax free" your main concern??
Brendan Burgess
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The investment decision is much more complex. You should be looking for , among other things, a high return after tax rather than an investment which is "tax-free" such as post office savings.
Duke of Marmalade
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Sorry, doesn't exist.
PO savings scores 100, 95 and 50 on your three criteria.LDFerguson
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I would suggest that the tax status of an investment should not be the primary concern. An investment should be chosen because of its suitability to your needs and wants.
That said, any investments held within a pension structure are exempt from CGT, DIRT and most other taxes. You also get tax relief on contributions. But you may well pay tax on some of the proceeds at retirement. So for many pensions are tax deferred investments rather than tax free.
That said, any investments held within a pension structure are exempt from CGT, DIRT and most other taxes. You also get tax relief on contributions. But you may well pay tax on some of the proceeds at retirement. So for many pensions are tax deferred investments rather than tax free.
Duke of Marmalade
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And just to be absolutely clear the deferral of itself confers no benefit as the taxman enjoys any growth on the tax deferred.
I don't think this last point is correct.
In a true gross roll up (not with a notional exit tax every 8 years) the fund is growing at a gross rate of return rather than a net rate of return.
Compounding at a higher rate of interest will result in a larger terminal fund value which wil of course be subject to personal taxes. But the net value of this fund should be greater than the fund available where taxes are paid as you go along since the effective rate of tax under both scenarios will be broadly the same the only difference being the gap between the net and gross compounding rates.
The imposition of the levy and the reduction in the amount of tax free cash available has complicated the issue but over a long term to retirement I would argue that the near gross pension environment will lead to a higher fund value for many investors.
The claim that is often put forward is that if you are a higher rate taxpayer that there is no additional benefit from pension contributions.
I would even refute this claim under certain conditions.
Consider someone who has very high medical bills in retirement. They can claim a 20% deduction on their income from their pension payments which makes the effective rate of tax payable on the pension income lower.
In a true gross roll up (not with a notional exit tax every 8 years) the fund is growing at a gross rate of return rather than a net rate of return.
Compounding at a higher rate of interest will result in a larger terminal fund value which wil of course be subject to personal taxes. But the net value of this fund should be greater than the fund available where taxes are paid as you go along since the effective rate of tax under both scenarios will be broadly the same the only difference being the gap between the net and gross compounding rates.
The imposition of the levy and the reduction in the amount of tax free cash available has complicated the issue but over a long term to retirement I would argue that the near gross pension environment will lead to a higher fund value for many investors.
The claim that is often put forward is that if you are a higher rate taxpayer that there is no additional benefit from pension contributions.
I would even refute this claim under certain conditions.
Consider someone who has very high medical bills in retirement. They can claim a 20% deduction on their income from their pension payments which makes the effective rate of tax payable on the pension income lower.
Duke of Marmalade
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Marc gross roll up is a genuine benefit in terms of returns, deferral isn't. Let me explain by example.
Scenario (a) No tax relief, gross roll up, no tax on benefits
Invest 50
trebles with gross roll up to 150
Net receipts 150
Scenario (b) 50% Tax relief, gross roll up, 50% tax on benefits
Invest 100, net outlay 50
trebles to 300
After tax receipt 150
Note that both scenarios are the same on a net net basis. Also note that in scenario (a) the taxman is totally uninvolved. In scenario (b) the taxman is actually also investing 50 upfront and receiving 150 in the end, he is matching the punter's investment. That is why the current regime is such a luxury at the present time, the tax man should not be investing in long term personal pension plans.
Scenario (a) No tax relief, gross roll up, no tax on benefits
Invest 50
trebles with gross roll up to 150
Net receipts 150
Scenario (b) 50% Tax relief, gross roll up, 50% tax on benefits
Invest 100, net outlay 50
trebles to 300
After tax receipt 150
Note that both scenarios are the same on a net net basis. Also note that in scenario (a) the taxman is totally uninvolved. In scenario (b) the taxman is actually also investing 50 upfront and receiving 150 in the end, he is matching the punter's investment. That is why the current regime is such a luxury at the present time, the tax man should not be investing in long term personal pension plans.
mandelbrot
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Is there not a tax-free lump sum of 25% on retirement?
And tax relief at 50% on all of the contributions, while only being taxed at the prevailing standard rate (as yet unknown) on the benefits...
Duke of Marmalade
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Yes absolutely, but these are ancilliary benefits of deferral and the regime. But I think that some people believe that there is a pure compound interest benefit in deferral. There is, but it accrues entirely to the Taxman.
There are two arguments there:
1) Gross roll up does not enhance the fund for the investor.
2) The tax man "should not be" investing in long term personal pensions.
1) In the examples you are describing different froms of "possible" tax structures.
Surely we should be considering the current alternatives for an Irish resident in 2012.
Otherwise I could argue that the UK Capital Gains tax allowance is extremely generous which combined with an ISA allowance makes pension provision less attractive for high earners. Yes, but we don't live in the UK.
So, the point I am making is that (ignoring for now the tax relief on contributions which depends on the marginal rate of tax paid) if I assume a rate of return of 6%pa for my investment strategy over a term of 30 years.
If I use a deposit structure I pay DIRT at 30% on my profits.
If I use a capital gains tax structure I pay CGT at a rate of 30% on my profits.
If I use a mutual fund or unit linked structure I pay tax at 30% on my profits if distributed and 33% if rolled up. Let's keep it simple and assume I have dividends paid out.
OK so, under most investment options outside of a pension I am paying 30% on my profits so my net return is going to be 4.2%pa.
Let's assume that the fees paid on my net investment are the same as those paid on my pension investment so we can discount the impact of running costs.
What return do I get in my pension? I get 6% my investment return less -what? There are no personal taxes on the profits. But let's assume that the levy of 0.6% applies in perpetuity.
I get 6%- 0.6% which is 5.4%pa.
So, ignoring the upfront tax relief.
If I invest €100 in a net fund I can assume a net investment return of 4.2%pa whereas in a pension I can assume a "gross" investment return of at least 5.4%pa (which assumes the levy stays with us forever)
Compound up my €100 over 30 years and I get:
Net fund €343.58 after 30 years
Gross Fund €484.42 after 30 years
This ignores the marginal benefits of any tax relief I obtained on my contributions and the benefit of being able to take some of this amount as a tax free lump sum and offsetting some of the taxable income against say medical expense deductions.
I am just looking at the gross roll up position. There is clearly a pure compound interest benefit available from a pension compared to a net fund. It is also probably bigger than I have calculated here because I have assumed the levy will be in place for 30 years. If that is the case there would be no pension funds left in Ireland to tax as they will have all fecked off to Malta!
So, yes, I agree that the marginal benefits of tax relief on contributions and the marginal rate of tax payable on the income will alter the shape of the benefits of a pension depending on the tax position of the investor.
However, the benefits of a gross environment accrue to all taxpayers.
2) This is a social policy question about whether governments should provide tax incentives for people to provide for their own retirements.
If the alternative is that the State has to provide these benefits then as a free-market kind of guy I would suggest that the market is the best mechanism for the provision of retirement structures and that the State should only step in to regulate and provide a safety net for those who cannot provide for themselves.
1) Gross roll up does not enhance the fund for the investor.
2) The tax man "should not be" investing in long term personal pensions.
1) In the examples you are describing different froms of "possible" tax structures.
Surely we should be considering the current alternatives for an Irish resident in 2012.
Otherwise I could argue that the UK Capital Gains tax allowance is extremely generous which combined with an ISA allowance makes pension provision less attractive for high earners. Yes, but we don't live in the UK.
So, the point I am making is that (ignoring for now the tax relief on contributions which depends on the marginal rate of tax paid) if I assume a rate of return of 6%pa for my investment strategy over a term of 30 years.
If I use a deposit structure I pay DIRT at 30% on my profits.
If I use a capital gains tax structure I pay CGT at a rate of 30% on my profits.
If I use a mutual fund or unit linked structure I pay tax at 30% on my profits if distributed and 33% if rolled up. Let's keep it simple and assume I have dividends paid out.
OK so, under most investment options outside of a pension I am paying 30% on my profits so my net return is going to be 4.2%pa.
Let's assume that the fees paid on my net investment are the same as those paid on my pension investment so we can discount the impact of running costs.
What return do I get in my pension? I get 6% my investment return less -what? There are no personal taxes on the profits. But let's assume that the levy of 0.6% applies in perpetuity.
I get 6%- 0.6% which is 5.4%pa.
So, ignoring the upfront tax relief.
If I invest €100 in a net fund I can assume a net investment return of 4.2%pa whereas in a pension I can assume a "gross" investment return of at least 5.4%pa (which assumes the levy stays with us forever)
Compound up my €100 over 30 years and I get:
Net fund €343.58 after 30 years
Gross Fund €484.42 after 30 years
This ignores the marginal benefits of any tax relief I obtained on my contributions and the benefit of being able to take some of this amount as a tax free lump sum and offsetting some of the taxable income against say medical expense deductions.
I am just looking at the gross roll up position. There is clearly a pure compound interest benefit available from a pension compared to a net fund. It is also probably bigger than I have calculated here because I have assumed the levy will be in place for 30 years. If that is the case there would be no pension funds left in Ireland to tax as they will have all fecked off to Malta!
So, yes, I agree that the marginal benefits of tax relief on contributions and the marginal rate of tax payable on the income will alter the shape of the benefits of a pension depending on the tax position of the investor.
However, the benefits of a gross environment accrue to all taxpayers.
2) This is a social policy question about whether governments should provide tax incentives for people to provide for their own retirements.
If the alternative is that the State has to provide these benefits then as a free-market kind of guy I would suggest that the market is the best mechanism for the provision of retirement structures and that the State should only step in to regulate and provide a safety net for those who cannot provide for themselves.
Duke of Marmalade
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Marc I am sure all that is true but if it is a reaction to my simple earlier comment, it is addressing much more than I was implying. I was simply saying that some people think that tax deferred is of itself a good thing, it was not adddressed at the likes of yourself who fully understand these matters. Some not so well versed might say "heck, not bad, I don't have to pay that tax relief back for 30 years, surely I enjoy the returns on it in the meantime." No! The taxman enjoys those returns.
Here, you do misunderstand my point. The tax code could provide all the current real benefits such as gross roll up, tax free lump sums, reduced taxation on the first tranche of benefits. This could be done without effectively investing alongside the punter in his personal pension plan. Think of it this way, a life assurance company holds very substantial accrued pension funds. These funds are needed to meet two future needs (a) the net needs of the policyholders and (b) taxation. Thus the taxman has a very real stake in those pension funds almost as much as the policyholders themselves. It is a long term asset which the taxman could make much better use of in today's conditions if somehow he could liquidate it.