I have looked at this question in some detail and the PRSA legislation is drafted in such a way to permit everyone to contribute to a PRSA irrespective of their earned income.
If you do not have earned income in the current year, contributions can be carried forward (seemingly without limit) until you have earned income to set against.
This legislation seems to be loosely based on the UK Stakeholder pension rules.
In the UK pensions can even be established for minors by the parent or guardian signing the application on behalf of the child. This is extremely tax efficient if contributions are paid by a grandparent as there is an inheritance tax saving into the bargin.
Equally, many people who are retired also contribute to pensions in the UK.
However, the difference in the UK is that everyone is entitled to basic rate tax relief at source.
So the position in Ireland for someone thinking about paying into a PRSA would appear to suit anyone who is not currently working but who expects to have earned income in the future so that they can offset contributions against future income tax, but who probably doesn't expect to be a member of an occupational pension scheme.
Example:
Consider the situation where a Grandparent has a sizeable estate that they wish to pass onto their two children but they are aware that the total value will be in excess of the total allowances available for their children (i.e. their estate is worth more than €500,000).
Let’s assume that the Grandparents have a grandchild aged 18 who is at University who has little or no income of their own.
Many Grandparents might be unhappy to make substantial outright gifts directly to their grandchildren, but many would be willing to invest in their future.
Under Irish CAT laws, the first €3,000 of the total value of all gifts received from one person in any calendar year is exempt. This means that the Grandparent or indeed the parent may give a gift of up to €3000 each and every year to their Grandchildren and this gift is immediately exempt from Capital Acquisitions Tax. This transfer results in an immediate tax saving of €900 each year under the current tax rate of 30%.
Rather than make the gift directly to their grandchildren, the grandparent could set up a Direct Debit to pay a premium of €3000pa to a Personal Retirement Savings Account in the name of the Grandchild.
Except in the case of an employee who is a member of an occupational pension scheme or of a statutory pension scheme, a taxpayer is entitled to tax relief on a contribution of €1,525 paid even if this exceeds the normal income-based limit.
Revenue provide an example as follows: If an individual aged 23 earns €9,525, the normal limit on the tax deductible contribution is 15% of €9,525, which equals €1,430.
If this individual pays €1,600, relief of €1,525 will be allowed, rather than the earnings based limit of
€1,430 .
Contributions paid in any year in excess of the maximum tax deductible contribution may be carried forward and claimed in future years subject to the annual limit for those years. Similarly, contributions paid while out of the workforce may be carried forward and claimed against future earnings on return to paid employment subject to the annual limits.
The tax relief is non-transferable between spouses in line with existing rules for retirement annuity contracts (RACs) and occupational pension scheme contributions.
A contribution not allowed in one year because it exceeds the age or income related limit may be carried forward and relief allowed in subsequent years. If a contribution is paid after the end of the year, but before the following 31 October, relief may be allowed in the earlier year provided an election to do so is made by the individual on or before the 31 October. Taxpayers filing returns under ROS may avail of the extended filing date to make an election and pay a contribution.
The practical upshot of these rules is that where the Grandchild is not earning significant income the unused income tax credits can be carried forward until such time as they have sufficient income to offset against the tax credits.
The benefit to the child or grandchild from the income tax relief depends on the ultimate rate of tax paid by the child but assuming they only obtain lower rate tax relief of 20% then based on the allowance of €1525, this equates to income tax relief of €305.
Therefore the cumulative effect of these two tax reliefs equates to €1205 against €3000 paid or a total of 40.1% in tax reliefs.
The grandchild cannot access the funds in the pension until they are at least 60 years of age satisfying the desire on the part of many grandparents to invest in their grandchild's future.
All profits and income generated within the pension fund are free of personal taxes (income tax and capital gains) and the fund is not subject to exit tax. Broadly speaking, this means that the investment gains are between 30% and 33% more tax efficient than alternative investment options and income earned is up to 41% more tax efficient.
Assuming an average investment return of 6.5%pa these tax savings might be expected to add around 2%pa compared to alternative forms of investment from which we currently need to deduct the pension levy of 0.6%pa leaving a net advantage of around 1.4%pa.
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