Does having a pension make sense if I don’t pay tax…at the moment?

I have a few Irish clients who don’t pay any income tax due to where they are living in the world. But they plan on coming back to Ireland when they retire. A simple investment account would seem the way forward, given that they are taxed in the country they are resident. But what about using a pension plan instead? Does this make sense?

The case for an investment account

It is the simplest thing to do, open a normal investment account. You are taxed in the country where you are resident. If you are in a Middle Eastern country, that means no tax at all. Before you come home, you cash in your investment to crystallise the gain. When you get back to Ireland, you reinvest the money, this time liable to tax at 41% on your gains. You can also access your money at any time you want.

Ross has been teaching in Dubai for the last 20 years. He has invested €30,000 a year for that period, growing at 5% per annum. It is now worth €991,978. He is going to cash that in while he is still a resident of Dubai and reinvest it when he returns to Ireland. This is his retirement money.

From the money that is reinvested, he will pay 41% tax on the gains made and nothing on the return of capital. If his investment continues to grow by 5% per annum, he can take an annual gross income of €63,902 for 30 years before the money runs out. Taking money out of investments, some money is a return of capital and some is growth and it will vary year to year. Averaging out the tax paid over 30 years, it amounts to €12,643 a year. That equates to a tax rate of 19.78%.

The case for a pension

A bit more outside the box, putting the money into a pension that accumulates tax free which it is in the pension product. You get no tax relief on the contributions and you cannot access the money until you reach age 60.

Robyn has been a doctor in Qatar for the last 20 years. She too invested €30,000 a year for that period, growing at 5% per annum. It is now worth €991,978.

When she gets home, she will take 25% as a lump sum, the first €200,000 of which is tax free. The remaining €47,995 is taxed at 20%, so €9,599 is deducted and she will receive €238,396. She will invest this to provide an income in retirement. Like Ross, she will pay tax of 41% on the growth of her money. She will receive €15,357 a year for 30 years and pay an average of €3,038 in tax, also 19.78%.

She invests the remaining €748,484 in an ARF returning 5% per annum. She can take a gross income of €46,371 for 30 years before the pot runs out. But unlike the investment where only the growth is taxed, all of the ARF is taxed as income under the PAYE system. PRSI is payable on withdrawals before age 66. In our example, Robyn is 66, so there is no PRSI deduction.

Of the €46,371 withdrawal, Robyn pays tax of €7,313 or 15.77% of her gross income.

When we add in the tax on the investment income and the tax paid on her lump sum, the average tax paid per annum is 17.29%, certainly lower than the investment option.

If the value of the pension pot is €800,000 or less, there is no tax on the lump sum. The total gross income is obviously less (€12,884 from the investment and €37,172 from the ARF) but the overall tax rate is down to 13.54%, a significant difference.

There is certainly a case for someone using a pension for funding if they are currently paying no tax where they live but do want to retire in Ireland.

Steven Barrett

11 December 2023