Budget 2023 made some interesting changes to pension funding. Under traditional company pensions, a company can make generous contributions but there was a formula used in calculating how much can be made each year which the company could claim tax relief against. This formula included your age, salary, current pension values and a computation factor that varied depending on your retirement age. You also had to submit proof of earnings to confirm that you were earning what you said you were. If you paid over that annual amount, you had to carry the tax relief forward to the next year.
Under the Finance Act, that funding check is gone. A company can put in as much as they want into a PRSA in any year and claim tax relief in the year that it was paid. The only limit is the overall €2 million cap. How can this be beneficial?
Tim is 55 years of age. He spent most of his working life abroad and never got around to starting a pension. He came back to Ireland a few years ago and for the last three years, he has been running his own business. He takes a salary of €20,000 a year but has built up a substantial amount of cash in the business.
Under the company funding rules, we have to take account of Tim’s salary, age, no retirement benefits and a computation factor based on his retirement age. We will use 60 as the retirement age to maximise this factor.
Tim can contribute €42,074 a year to his pension for the next five years. That’s a total of €210,370.
If he wants to contribute more to his pension, he will have to increase his salary, which he doesn’t want to do as he will have to pay more tax.
Tim can contribute up to €2 million to his PRSA over the next number of years. Subject to actually having the cash, that’s €400,000 less growth, almost ten times the amount allowed under a company pension plan.
Ruth and her husband Gareth are 50 years of age and have accumulated a lot of personal savings over the years. It is all sitting in cash. They know they should so something with it but they are not attracted to the investment taxation system in Ireland.
They have pensions of €500,000 each already and based on their incomes of €75,000 each, they can contribute €124,400 to their pensions each year. They run a profitable company and have found the funding limits a bit restrictive in the past.
Given they have money sitting in cash, they can start using this to live off. They can reduce their incomes from the company and redirect this money into their pensions.
Under the company funding rules, if they reduced their income to €40,000 each so they pay 20% tax, the amount they can contribute to their company pension will also be reduced. Running a new funding check, that new amount is reduced to €40,400 a year.
Under the new PRSA rules, they can reduce their income to €40,000 each (or less). They don’t have to stop funding the existing company pension they have but the amount will be reduced to €40,400.
The PRSA can act as an “overflow” plan and they can contribute the remainder of the old funding level (€84,000) plus the savings in salary (€35,000). That is a total of €159,400 going into their pension now and they receive a reduce income of €40,000 each. There is no additional cost to them.
If there is additional cash in the business, they can invest this in the PRSA, as long as they stay within the €2 million overall limit.
These changes in company funding rules through PRSA’s has opened up lots of opportunities for company directors who have the flexibility to change their income and pension funding to suit their needs.
20 February 2023