What happens if my pension is over €2m threshold?

Up until 2005, you could have as big a pension pot as you wanted. Then, because some very wealthy people took advantage of this rule, a cap of €5m was imposed. This was increased to €5,418,085 by 2008 before it being reduced to €2.3m in 2010 and further still to €2m in 2014. The majority of people won’t have a pension pot anywhere near €2m. But if you are earning a good salary, especially if a hospital consultant or member of the judiciary, there is a good chance you will go over this threshold. What happens to your pension then?

If your pension was valued at over €2m on 1 January 2014, you can apply to the Revenue for a Personal Fund Threshold (PFT). For the purpose of  this article, we assume you don’t have a PFT and have gone over the €2m limit, which is known as the Standard Fund Threshold (SFT). Any amount over this limit is called Chargeable Excess (we have lots of jargon!).

There are some different options available to those with public service pensions, so I will highlight the options that are available to public servants.

For all examples, I am assuming:

• Our client, Dr A, earns €200,000 a year in her role as a hospital consultant with the HSE. She will be entitled to a pension of €100,000 at retirement and a gratuity of €300,000.
• She has total pension benefits valued at €2.5m. This is made up of her public pension valued at €1.7m and private pensions valued at €800,000.
• The chargeable excess is €500,000.
• Of that €2.5m, she is entitled to a lump sum of €500,000. Under current rules, she can take €200,000 tax free. The remaining €300,000 is taxed at 20%, creating a tax liability of €60,000. This will become relevant later on.

Defined Contribution Option

If you have a Defined Benefit Option, it is important that you mature the DB pension first. As Dr A’s defined benefit pension is valued under €2m, when she mature it, it doesn’t trigger the Chargeable Excess. She then matures her private pensions, which puts her over the €2m limit.

• Chargeable excess – €500,000
• Tax at 40% – €200,000
• Tax credit from lump sum – (€60,000)
• Net tax – €140,000

The 20% tax paid on any lump sum creates a tax credit that can be offset on her tax liability on any chargeable excess. The €140,000 can be deducted from her pension fund. The remaining €360,000 excess can then be invested in an ARF, taken as taxable cash or you can purchase an annuity. Either way, more income tax will be paid.

• Tax Paid up front – €140,000
• Tax Paid over lifetime – €158,400
• Total tax paid – €298,400

Defined Benefit Option

Under this option, you mature your defined contribution pensions first. As the value of this pension is under the SFT, there is no chargeable excess for this part.

If you are a member of a private defined benefit scheme, the excess can be paid through taking a reduced pension from the defined benefit scheme. The amount of this reduction will be actuarially calculated.

The public service method is a lot simpler, you pay off the tax over 20 years.  It is interest free and the debt dies with you if you die within the 20 year period.

• Chargeable excess – €500,000
• Tax at 40% – €200,000
• Tax credit from lump sum – (€60,000)
• Net tax – €140,000
• Deduction of defined benefit pension €7,000 a year

Dr A’s public service pension will be reduced by €7,000 a year to €93,00 for 20 years. It will increase back to €100,000 after 20 years. If she died during that time, the debt is dies with her. The spouse’s pension paid is based on the higher pension of €100,000, so her husband will receive €50,000 spouse’s pension.

Like in our first option, the taxes relating to her private pensions which are causing the chargeable excess are subject to income tax and USC and PRSI up to age 66.

• Tax Paid up front – Nil
• Tax Paid over lifetime – €305,000
• Total tax paid – €305,00

Under this option, the Revenue assume all of the mortality risk. If you die within the first 20 years, the debt is wiped without being recouped.

Encashment Option

The Encashment Option was introduced in 2012 following lobbying from by the judiciary and only applies to the public service. If a public servant, likely a judge, hospital consultant or high ranking civil servant,  who has private pensions as well as public service pensions, they can surrender part or all of their private pension and wipe out the chargeable excess.

In our example, Dr A has a total pension fund valued at €2.5m, creating a chargeable excess of €500,000.

• Chargeable excess – €500,000
• Private pension to be encashed – €500,000
• Encashment tax at 48% – €240,000
• Net fund – €260,000

She has just taken €500,000 out of her pension in one go, so the remainder is now worth €2m  and no longer subject to chargeable excess.

• Upfront tax – €240,000
• Ongoing tax – Nil
• Total tax – €240,000

Of course, if she invests the remaining €260,000, any gains made will be subject to tax on the gains. She has also paid all of her tax liability up front and in one go. If she dies young,

In general, people avoid making large tax payments, so they are happier to receive a reduced pension over 20 years than pay a large lump sum up front. Also, when people retire, they suddenly start thinking they will die young and won’t get the value of their pension pots. So they would certainly prefer for the Revenue to assume the mortailty risk rather than take it on themselves.

If you have any questions, send me an email at steven@bluewaterfp.ie