The Standard Fund Threshold is a topic that many advisors and clients feel should be the focus of high net worth clients only, however this is not the case. Modest funding over a long period of time can lead to ‘average’ clients breaching the threshold. The potential to breach the threshold may be further compounded by the current political focus on the threshold. While Sinn Fein’s desire to bring the threshold in the Republic in line with that of the North (£1,073,100) may not come to pass, it does make it unlikely that the current €2,000,000 Irish Threshold will increase in the coming years.
So, what can you do as an advisor to help your clients avoid paying the punitive excess fund tax? The simple answer is to keep the threshold in focus at all times when discussing pensions with your clients. It can be difficult to do this during ‘pension season’ when the clients main focus is on reducing an immediate tax bill, however refocussing your client on long term planning can avoid them generating an unnecessary tax bill in the future.
To illustrate this, we will look at a number of examples where seemingly ordinary clients can create an excess fund tax problem for themselves in the future purely by being good savers. For the below examples I will be making a number of assumptions:
- The Standard Fund Threshold will remain unchanged,
- Long term investment growth will be 5% p.a. net of all fees
- Annual Contributions index at 3% p.a.
In the first scenario if we look at a 40-year-old client with a pension fund of €400,000 making an annual contribution of €20,000. Although the amounts do not seem excessive the client could end up with a pension fund of €2.7 million at 65 leading to an excess fund tax of €224k.
How could good financial planning help a client in this situation? The most obvious solution for the client would be to retire the pension fund shortly after reaching age 60 when it achieved the important value of €2,150,000 (€2,150,000 allows the client to retire the scheme, and offset the €60,000 tax payable on the €500,000 retirement lump sum against the excess fund tax due of €60,000). This option may lead to a situation where the client is unnecessarily paying tax on annual income from an ARF or an annuity while they are still working full time. The second and perhaps more favourable option for this client, to mitigate the breach, would be to reduce or stop the annual contribution well in advance of approaching the Standard Fund Threshold, thereby allowing for future growth and possible some element of contributions closer to retirement.
In the second scenario if we look at a 50-year-old client with a pension fund of €1,000,000 with the intention to retire at 65. If the client ceases contributions immediately they could have a pension fund of just under €2.1 at age 65. There is a strong temptation to simply accept a contribution from the client in the run up to the pay and file deadline, however proper planning could avoid creating a significant problem for the client in later years.
Finally, we will look at a client aged 30 who is starting a pension and saving €12,000 per annum with the intention of retiring at the age of 65, in this case the contributions will increase by 6% each year.
Again, the amounts do not seem excessive, however the client could end up with a pension fund of €2.73 million at 65 leading to an excess fund tax of €233k.
So, what is the takeaway from these examples?
Firstly, the earlier you fund a pension the easier it is to amass a significant sum. Secondly the time to start planning for a Standard Fund Threshold breach is as soon as your client starts their pension.
If someone is already in breach of the Standard Fund Threshold or will be before their normal retirement age, there are some solutions available:
- It may be possible to retire the scheme immediately if the client is over the age of 50 and can move to another employment or cease working. If the client is a company owner, they would need to cease all ties with the company from which they will retire. It is important to remember that a pension scheme can be transferred from one company to another if required.
- A client may defer drawing down some or all of their pension fund. The excess fund tax is only chargeable on certain transaction’s (retirement & overseas transfer), if a client dies before drawing a pension fund the excess fund tax is not applied. The use of multiple PRSA’s can be very beneficial in this scenario as it allows for split retirement while also allowing clients to plan around the four times salary problem that large occupational pension schemes often fall foul of.
- The final option is to move the scheme interstate to an IORP approved pension product. Interstate transfers are benefit of crystallisation events. This means that if the pension fund is in excess of the Standard Fund Threshold at the time of transfer, the excess fund tax must be paid immediately. After the fund arrives in the receiving pension scheme it is now that states pension rules that govern any excess fund tax. In many states such as Malta, pension funds can grow to any size without incurring any penalties. It is important to note that a Bona Fide Declaration must be completed and submitted to Revenue for such transfers.
To summarise, there are a number of options available to pension investors who are in the fortunate position of having built up a pension pot sizable enough to generate an excess fund tax. Financial advisors can help their clients save significant tax bills through some complex planning after the problem has already arisen. More importantly good cash flow modelling on an annual basis should avoid an excess fund tax issue arising in the first place.
Author: Eoin Hassett, Independent Trustee Company. For further information, please email email@example.com.