May 24, 2019
We should each year renew our focus on pensions and ensure that with proper planning, we can provide for a comfortable steady income in Retirement.
We are all too aware of the fact that the level of pension coverage in Ireland is quite poor. Too few people have pensions. Therefore this means people will have to work longer to maintain an adequate standard of living or live off the State pension when they eventually get to draw this down; and as you well know, that pension age is gradually being pushed out as a consequence of people living longer. It will go to 67 from 2021 and to 68 from 2028.
We at, John M Shanahan & Co, Chartered Accountants, Tullamore, Co Offaly have taken a look at focusing on company pension schemes for owner company directors and looking at options at retirement in terms of drawing down the funds.
Where is the starting Point.
The key point here is that you need to get your pension up and running. Not next year, next month but take action and get going now. The sooner you start the better and give yourself a better chance of having a decent pension pot at retirement. Of course its better if you start in your 20’s than if you start in your 40’s, the later you start the more money you will have to sink to arrive at the type of pension you want to achieve.
Why a Company Pension.
The main reason is that the company makes the pension contribution for you so you don’t have to make the payment out of your net salary. Therefore your net salary stays the same but the company is using its cash to fund your pension. The company get a tax deduction for the payment so it is treated as an expense in the accounts. Although the saving is only at 12.5% it is still a saving so a monthly contribution of €1,000 would be a net cost to the company of €875. Another benefit is that the income and gains in the pension roll up tax free. This is fantastic as there are not many things in life that you will get tax free! The benefit of this is that as there is no tax on the income or gains within the pension so the fund can grow to a significant amount over time assuming investment performance is good and charges are reasonable.
The Company's money, not yours.
The company is contributing funds to the Director’s pension so what is happening is that company money is being converted into a personal asset of the company director. I see this as a form of long term savings for the director. In the unfortunate scenario of the director passing away during the term of the pension then the value of the pension is paid out to the spouse or to the Estate of the director. Therefore this would be a cash payment, like the proceeds of a life assurance policy, to the director’s family. If that went to the spouse there would be no tax on it and there may or may not be tax on it if going to other family members. Assuming the director makes it to retirement then the pot of money that has been accumulated is available to draw down and is an asset of the director, in most scenarios.
The drawdown Option.
There are a number of options available and the key options you need to know about are;
The maximum tax free lump sum that you can get when drawing down a pension is €200,000. Therefore to get this maximum you need a fund of €800,000. Assuming you have this amount in your fund and you take your tax free lump sum you are left with €600,000. That can either be invested into an Approved Retirement Fund [ARF] or an Annuity. If investing into an ARF you can draw down this as you please, subject to normal tax rates, so there was a fear that you would deplete your ARF quickly and that you would have no Capital left. Therefore the Approved Minimum Retirement Fund (AMRF) was introduced where you would have to put a minimum of €63,500 of the balance of your pension fund into an AMRF, the capital of which couldn’t be touched until you hit 75. You didn’t have to invest into an AMRF if you have a guaranteed income for life of €12,700 at the time of drawing down of your pension. The guaranteed income could either be a state pension or another private pension.
The ARF V Annuity route.
The key benefit of going down the ARF/AMRF route is that the pension is your asset on which you can draw down an income from every year. This is effectively another pension asset and the income and gains roll up tax free in the fund, while the income you draw down is subject to tax. However your tax rate at retirement age may well be a lot lower than it is when you are working as you could have a reduced income but would hopefully have reduced outgoings also.
Taking the above example if you drawdown 5% of your ARF annually on a figure of €600,000 this would be an annual pension of €30,000. If you were also in receipt of the State pension that is an additional income of €13,000 so your combined pensions are €43,000. If you are married and this was your only income then all of this would be taxed at the lower tax rate of 20%, under current tax rules.
If you purchase an annuity you are giving the balance of your pension to an Insurance company and they will pay you an income for life which would be based on current interest rates. Annuity rates are quite low at the moment so your fund would have to be very high to get sufficient income. The key disadvantage of an annuity is the early death of the annuity holder. If you die early in your retirement the Insurance company will keep the remainder of your money. As opposed to an ARF an annuity is not your asset but that of the life company from whom you purchased the annuity.
As an owner director of your company it is very important to plan for this. When meeting prospective clients a question we will always have on our agenda would be business exit and what the long term intentions of the business owner are. The reason we ask this is that we want the business owners that we work with to be taking steps to plan for their retirement and their business exit.
We at JOHN M. SHANAHAN & CO. are here to help you with all your accounting, business, financial and taxation requirements, by providing expert, specialist and professional service tailored to meet your needs.