Report of the Commission on Taxation and Welfare – Pensions

The Report of the Commission on Taxation and Welfare was published last week. At 547 pages, this is a lengthy document and there is a huge amount of recommendations in it. As there is enough just on pensions, that is what I am going to concentrate on now. I will come back to some of the other recommendations later.

Pre Retirement – Marginal Tax Relief

The Commission looked at a number of different contentious issues that are often brought up when it comes to discussing saving for retirement.

They look at tax relief on pension contributions which is currently given at your marginal rate. In other words, if you pay 40% income tax, you get 40% income tax relief on your pension contributions. Some think this is unfair as people who pay tax at the 20% rate don’t get the same relief (higher earners pay more income tax, so it is equitable that they get higher relief. It would be unequitable if someone paying tax at a lower rate gets higher tax relief on their pension but lower taxation on income both in their working lives and in retirement). The Auto Enrollment scheme won’t operate on a strict tax relief basis but a government contribution instead which will work out as the equivalent of 30% tax relief.

The Commission concluded that the existing approach of marginal relief was appropriate on the basis that the contributions represent a deferral of income; that is the Revenue will get the tax income in the future. It did put the caveat that this is as long as other recommendations are implemented.

Pre Retirement – Contribution Limits

The Commission looked at the limits in place on how much people can contribute to their pension. Currently, there is an earning cap of €115,000 on which you can claim tax relief on pension contributions. The percentage of salary you can contribute is limited based on your age (subject to earning cap).

<30 – 15%

30 – 39 – 20%

40 – 49 – 25%

50 – 54 – 30%

55 – 59 – 35%

60+ – 40%

The Commission states that due to the different nature of working now, people’s earning capacity and salaries have changed and some may be earning more in earlier years than in later years. They should be allowed to able to make larger contributions if they want. They recommend that a flat rate is introduced and not an age related one. They also recommend the removal of the €115,000 earning cap.

Post Retirement – Tax Free Lump Sum

The Commission believes that the current tax free lump sum of €200,000 is excessive and should be reduced. They don’t agree with the favourable tax treatment of lump sum amounts between €200,001 to €500,000 which are taxed at a flat 20% and not the marginal rate, nor that it is not subject to USC.

They also looked at where some individuals may receive a tax free lump sum on departure from employment of up to €200,000 and their pension tax free lump sum. They recommend the introduction of a single lifetime limit that includes both the ex gratia payment and pension tax free lump sum.

Post Retirement – ARF on Death

On death, an ARF passes to a spouse tax free and becomes an ARF in their name. If it passes to children over the age of 21, it is taxed at 30% and is not liable to tax under CAT. The Commission believes that there being no clawback of tax relief that was given at contribution stage acts as a disincentive to draw down an income in retirement and to use the ARF to fund an inheritance.

Their recommendation is that ARFs passing to children on death are subject to both Income Tax and CAT. This will make ARF holders draw down more money in retirement.

This was addressed by the introduction of deemed disposal where ARF holders have to withdraw 4% a year from age 61 and 5% from age 71%. This can be a higher tax income for the Revenue than those who purchased an annuity. For a beneficiary of an ARF, if they have already used up their CAT threshold, it would have the effect of paying 68% pf the ARF value to the Revenue.

Post Retirement – Standard Fund Threshold

The maximum value to your pension is €2 million. Anything over that is subject to tax at 40% and the remainder is then subject to tax under PAYE when it is drawn down.

For public servants, there are a number of options available to pay the tax if they exceed the threshold. This includes an option to have your pension reduced for 20 years to pay off the tax, interest free. The debt dies with you if you die before the tax is paid off. The Commission recommends that the options be the same across all pension arrangements.

They also recommend that the threshold level is reviewed and benchmarked regularly to an appropriate and fair levels of retirement income having regard to the prevailing market earnings.

Post Retirement – PRSI

If you receive an annuity or a defined benefit pension, you don’t pay any PRSI on the income you receive regardless of when you retire. People over the age of 66 do not pay PRSI on their income.

The Commission recommends that both those receiving annuities and those over age 66 continue to make PRSI contributions. Only social welfare payments should be exempt from PRSI contributions.

Steven Barrett

19 September 2022