There are no zero cost and zero tax options so you need to make a comparison between some different scenarios all of which could leave a financial benefit.
1) pay in and obtain the 40% tax relief. Defer the pension to age 75. If you die before you reach age 75 your spouse or civil partner receives the whole value of the fund tax free. No income tax, no capital gains tax, no CAT and no penalty tax if you exceed the lifetime €2m allowance.
Conclusion: life insurance with tax relief on the premium
2) gross roll up.
Let’s say you invest in equities and the return is say 7.2%pa net of charges to keep the maths easy.
Now let’s say a fund held directly also pays 7.2% net of charges but is subject to personal tax.
Your pre-tax €10k will be worth €20k in 10 years time.
Whereas if you invest the net income that’s going to be about €5000 which if you invest today you will have €10 in the fund (rule of 72)
You will then lose a further 41% in exit tax so €2,050 in tax. Net position €7,950 vs €20,000.
So let’s assume that you always have a marginal rate of tax of 50% and that you’ve used up all your lump sum entitlement. Taking that €20,000 as a lump sum fully taxable at your highest marginal rate is still going to leave you with a net €10,000 compared to €7,950.
In effect you received an interest free loan from Revenue and the difference is the gain on the income tax deferred.
If you invest in something that’s subject to CGT you will be taxed at 33%
If you pay income tax you will lose your marginal rate of tax (up to 55%)
So a pension gives you gross roll up relative to any other option you will have a larger gross fund in the future and the longer you leave it the more this will compound in your favour.
3) taxable lump sum
Even if you have a pension fund of €800k and can use up the tax free lump sum the next €300,000 of lump sums is only taxable at 20%
4) not all of your pension is taxable.
Imagine you have an ARF with €1m and you are forced to take an income of 5% which is subject to income tax at your marginal rate of 40% plus USC
In this example ; 95% of your ARF is not subject to tax. See earlier argument about gross roll up.
Assume your ARF grows every year so the value rises back to €1m.
Effectively your ARF hasn’t paid any tax it’s constantly deferred. You are only paying income tax on the income distribution not the original tax deferred capital.
When you die your spouse or civil partner inherits the ARF then adult children inherit at a rate of 30% which doesn’t count towards the CAT thresholds so these are also available.
Had you held those assets personally and the CAT thresholds had been used up then the kids would pay an additional 3% tax €30,000 tax saved
5) match withdrawals with medical expenses
Imagine you have an ARF with a million and in your 70s you incur €100k of medical expenses. That year you should take a larger withdrawal from the ARF partially to meet those expenses but partly because you can claim 20%tax back on medical expenses. That’s a €20 grand tax rebate
Marc Westlake
Chartered Certified and European Financial Planner
www.globalwealth.ie
globalwealth.ie
