Does it make sense to cash an old pension at 50 and contribute the funds to a new pension?

[Brendan Burgess]

This issue comes up from time to time (e.g. here ) , and my instinct is that it is wrong. But I want to check my instinct.

What are the rules about cashing a pension early?

If you have an old pension fund, say €100k, and you hit 50, you can access it early.
This means you can take €25k tax-free and take the rest as an ARF.

So if you invest the €25k in new pension contributions in your new job.
Assuming you can't afford to make contributions from your income, but now you have €25k cash, you can contribute.
This is the equivalent of putting €40k into a pension fund and getting 40% tax relief.

When you eventually retire, you will get €10k tax free.
And probably pay 20% tax on the €30k or €6k - leaving you with €24k.

So, have you turned €25k into €34k by cashing a pension and reinvesting it?

You can also invest the drawdown from the ARF but I think that is neutral.
If I take €10k from the ARF, I will pay about 45% (tax and USC?) on it.
But if I put it back into a pension fund, I will get tax relief.

 

[Dr Strangelove]

I think it makes sense if the 25% is large enough, you need it, and you can up your contributions to match what you start to draw down from the ARF. All else equal it makes sense to draw down the lump sum early for a home renovation than the alternative of borrowing at 7% or 8% from the credit union.

It takes a fair bit of discipline though which some people might not have. So I wouldn’t recommend it for its own sake.

Edit: there is also the issue of USC and PRSI which you will pay on ARF drawdowns but won’t get relief in as you put them back in to your new pension fund.

I think this needs a worked example and I don’t know enough about the tax and fee treatment to do it.

 

[bish123]

For sure, the lump-sum can be used for paying mortgage without going through Revenue cycle again.
In most common hypothetical scenario, if someone has outstanding mortgage of €200,000 at 50 with full term finishing at 65. If they cash out at 50 and pay €25,000 lump-sum in mortgage. They saved €12,868.31 presuming 3% interest rate so converting €25,000 into €37,863.

 

[Gordon Gekko]

My sense is that there are two main advantages, 1) Paying down debt, 2) Taking future growth out of the Standard Fund Threshold calculation. For example, I can access a decent amount of tax-free cash at age 50 which will be enough to kill-off my mortgage. I’m struggling to see the downside.

 

[Dr Strangelove]

They saved €12,868.31 presuming 3% interest rate so converting €25,000 into €37,863.

Yes but a reasonable assumption is that leaving the €25,000 where it is for 15 years would yield more than 3% p/a!

I really think the hurdle rate for ARF withdrawal is more like personal lending terms of around 8%.

 

[Brendan Burgess]

The bit which is confusing me is that many people on askaboutmoney recommend contributing to a pension fund rather than overpaying the mortgage.

This seems to be the opposite.

I could be persuaded if the interest rate on the mortgage is very high but it still seems wrong.

A worked example with an ordinary mortgage rate of about 4% would help clarify.

Brendan

 

[Dr Strangelove]

The bit which is confusing me is that many people on askaboutmoney recommend contributing to a pension fund rather than overpaying the mortgage.

It’s a question of risk and age.

Someone with a mortgage or 3x income in their 30s is fine and should prioritise pension. Someone in 50s with a mortgage of 3x income could struggle and should deprioritise pension.

 

[bish123]

The bit which is confusing me is that many people on askaboutmoney recommend contributing to a pension fund rather than overpaying the mortgage.

This seems to be the opposite.

I could be persuaded if the interest rate on the mortgage is very high but it still seems wrong.

A worked example with an ordinary mortgage rate of about 4% would help clarify.

Brendan

In this case we are not comparing pension versus overpaying mortgage, instead using these schemes in sequence versus one scheme. By retiring a fund at 50, one can take advantage of both these schemes- contributing pension (and saving higher tax @40%) and then using 25% tax free lump-sum of this fund and save compound interest on mortgage.

Using 4% compound interest, someone can save €18,318.54 on €25,000 lump-sum payment in mortgage at 50 by retiring a fund of €100,000 so effectively converting it into €43,318.54. If they leave it in the pension fund, the effective return after 15 years may be more depending upon market return. It's back to the preference of individuals. A large proportion of people like to add funds to brick and mortar with a roof, than a scheme they have no control off.

 

[S class]

If I take €10k from the ARF, I will pay about 45% (tax and USC?) on it.

You will also pay Prsi at 4% (this will start increasing from October)

 

[Redzer]

This issue comes up from time to time (e.g. here ) , and my instinct is that it is wrong. But I want to check my instinct.

What are the rules about cashing a pension early?

If you have an old pension fund, say €100k, and you hit 50, you can access it early.
This means you can take €25k tax-free and take the rest as an ARF.

So if you invest the €25k in new pension contributions in your new job.
Assuming you can't afford to make contributions from your income, but now you have €25k cash, you can contribute.
This is the equivalent of putting €40k into a pension fund and getting 40% tax relief.

When you eventually retire, you will get €10k tax free.
And probably pay 20% tax on the €30k or €6k - leaving you with €24k.

So, have you turned €25k into €34k by cashing a pension and reinvesting it?

You can also invest the drawdown from the ARF but I think that is neutral.
If I take €10k from the ARF, I will pay about 45% (tax and USC?) on it.
But if I put it back into a pension fund, I will get tax relief.

I did a very similar version of this last year aged 55 and I think it made sense. I'm not clearly following the numbers above so below is my version.

I was unable to maximise my contributions from Income so cashed in an old PRB from previous employment of approx. €100k.
I put approx. €75k into an ARF and got approx. €25k as a Tax Free Lump Sum and immediately put that into my current DC Pension as an AVC for 2022.
I then got 40% tax relief from Revenue of approx. €15k for that €25k 2022 AVC which I also immediately put into my current DC Pension as an AVC for 2023.

My total pension pot values increased last year by approx. €15k through above accessing the Income Contribution limits in a timely manner. I'm aware that the 4% imputed distribution will kick in when I'm 61 but I don't think that the tax bill liability will be as large as benefit of the compounded €15k especially if I am in a position to retire at that stage and possibly not paying tax at the 40% rate. E.g. Suppose the approx. €75k ARF grows to €100k in the next 6 years then the 4% distribution equates to €4k with an Income Tax liability of either €800 (@20% rate) or €1,600 (@40% rate). Even if I was paying at the 40% rate for 6 years (unlikely in my situation) and it cost me >€9.6k tax for cashing in the PRB, I'm hopefully benefiting from the compounding on the €15k of more than that plus the after tax income of the imputed distribution?

As an aside, I also still have a €90k ECB+0.5% tracker mortgage that I'm hoping will have lower interest rates than the ARF market return over the next several years (due to be paid off when I'm 65). I intend to pay it off sooner with the lump sum from my current DC pension if I am able to take early retirement from my current scheme. I'm hoping that the ARF compound effect of the €25k plus €15k will outweigh the the opportunity cost of the Tracker paydown plus the net Imputed Distribution costs.

 

[dubdub123]

I did a very similar version of this last year aged 55 and I think it made sense. I'm not clearly following the numbers above so below is my version.

I was unable to maximise my contributions from Income so cashed in an old PRB from previous employment of approx. €100k.
I put approx. €75k into an ARF and got approx. €25k as a Tax Free Lump Sum and immediately put that into my current DC Pension as an AVC for 2022.
I then got 40% tax relief from Revenue of approx. €15k for that €25k 2022 AVC which I also immediately put into my current DC Pension as an AVC for 2023.

My total pension pot values increased last year by approx. €15k through above accessing the Income Contribution limits in a timely manner. I'm aware that the 4% imputed distribution will kick in when I'm 61 but I don't think that the tax bill liability will be as large as benefit of the compounded €15k especially if I am in a position to retire at that stage and possibly not paying tax at the 40% rate. E.g. Suppose the approx. €75k ARF grows to €100k in the next 6 years then the 4% distribution equates to €4k with an Income Tax liability of either €800 (@20% rate) or €1,600 (@40% rate). Even if I was paying at the 40% rate for 6 years (unlikely in my situation) and it cost me >€9.6k tax for cashing in the PRB, I'm hopefully benefiting from the compounding on the €15k of more than that plus the after tax income of the imputed distribution?

As an aside, I also still have a €90k ECB+0.5% tracker mortgage that I'm hoping will have lower interest rates than the ARF market return over the next several years (due to be paid off when I'm 65). I intend to pay it off sooner with the lump sum from my current DC pension if I am able to take early retirement from my current scheme. I'm hoping that the ARF compound effect of the €25k plus €15k will outweigh the the opportunity cost of the Tracker paydown plus the net Imputed Distribution costs.

This is along the lines of the situation that I am in however the amount in my previous pension is lower.
Would appreciate any input on the following


Pension from previous company is 40k
Scenario 1A:
Considering the 25% tax free amount gives an amount of 10k.

Action: take this amount and put into current pension --> gives 16K+

Scenario 1B:
Considering the 25% tax free amount gives an amount of 10k.

Action: Put this full amount towards loan with 5.7% rate.
Redirect my monthly 600 payment for loan into AVC which is 1,000pm
Loan is paid off. Money is moved into new pension but at slower rate.


Scenario 2A:
Considering the remaining 75%
Action: roll into ARF and drawdown min amount from age 61. Assume its worth 40k then.
4% distribution gives 1,600pa before tax
--> 106pm @ 20%tax or
--> 80pm @ 40% tax


Scenario 2B:
Considering the remaining 75%
Action: move this into current company pension

Assuming taxed at 20% (is this correct?), prsi at 4%, usc at 8%
--> leaves 20,400

If moved into current pension its worth 34,000


So if i moved everything into current pension it would be approx 34k + 16k so 50k, which i could put in for 2023 and 2024 years.

Any thoughts? Would really like to hear of potential pitfalls, things i may have overlooked eg fees etc. Thank you

@Brendan Burgess @Redzer

 

[Redzer]

This is along the lines of the situation that I am in however the amount in my previous pension is lower.
Would appreciate any input on the following


Pension from previous company is 40k
Scenario 1A:
Considering the 25% tax free amount gives an amount of 10k.

Action: take this amount and put into current pension --> gives 16K+

Scenario 1B:
Considering the 25% tax free amount gives an amount of 10k.

Action: Put this full amount towards loan with 5.7% rate.
Redirect my monthly 600 payment for loan into AVC which is 1,000pm
Loan is paid off. Money is moved into new pension but at slower rate.


Scenario 2A:
Considering the remaining 75%
Action: roll into ARF and drawdown min amount from age 61. Assume its worth 40k then.
4% distribution gives 1,600pa before tax
--> 106pm @ 20%tax or
--> 80pm @ 40% tax


Scenario 2B:
Considering the remaining 75%
Action: move this into current company pension

Assuming taxed at 20% (is this correct?), prsi at 4%, usc at 8%
--> leaves 20,400

If moved into current pension its worth 34,000


So if i moved everything into current pension it would be approx 34k + 16k so 50k, which i could put in for 2023 and 2024 years.

Any thoughts? Would really like to hear of potential pitfalls, things i may have overlooked eg fees etc. Thank you

@Brendan Burgess @Redzer

Scenario 1A gives you a "free" pension boost of €6k which then gets to compound tax free. Depending on what fund(s) your pension is invested in, it may grow slowly in a conservative, low risk fund or faster in a more volatile, higher risk fund depending on your risk appetite and your investment horizon. While I'm hoping to retire from my current job in the next 5-7 years, I am hoping that my pension pot will be needed for the next 20+ years so I've opted for the more volatile funds.

Scenario 1B gives you an interest cost saving. You don't say the loan amount or the remaining term but I'm sure you can calculate the saving based on €X for Y years at 5.7%. If that saving is more than €6k then this scenario 1B is preferable, otherwise 1A is better.

You can of course do a version of both where for example you put €5k into the pension pot (and get €3k boost) and also pay €5k off the loan. The €3k boost can then be put into the pension or also used to help pay off the loan.

Re Scenarios 2A and 2B - I believe that you must roll the remaining 75% into an ARF (or purchase an annuity) so only 2A is an option.
You may also potentially be able to negotiate more favorable ARF charges than your current Pension fund charges.

 

[Gordon Gekko]

Do the maths of this make sense? I’m not sure TBH. I have €24 in my pension fund. I can withdraw €6 tax-free. I then stick that €6 into a new pension fund and it gets topped-up by €4 in the form of tax relief. So now I have €10 compounding away tax-free whereas previously I only had €6.

I guess if it’s the only way the person can afford to contribute to the new pension, it makes sense. But a better outcome would be to keep both working away in the pension funds.

 

[dubdub123]

Scenario 1A gives you a "free" pension boost of €6k which then gets to compound tax free. Depending on what fund(s) your pension is invested in, it may grow slowly in a conservative, low risk fund or faster in a more volatile, higher risk fund depending on your risk appetite and your investment horizon. While I'm hoping to retire from my current job in the next 5-7 years, I am hoping that my pension pot will be needed for the next 20+ years so I've opted for the more volatile funds.

Scenario 1B gives you an interest cost saving. You don't say the loan amount or the remaining term but I'm sure you can calculate the saving based on €X for Y years at 5.7%. If that saving is more than €6k then this scenario 1B is preferable, otherwise 1A is better.

You can of course do a version of both where for example you put €5k into the pension pot (and get €3k boost) and also pay €5k off the loan. The €3k boost can then be put into the pension or also used to help pay off the loan.

Re Scenarios 2A and 2B - I believe that you must roll the remaining 75% into an ARF (or purchase an annuity) so only 2A is an option.
You may also potentially be able to negotiate more favorable ARF charges than your current Pension fund charges.

This is great information.
My loan is now at 13,500 at 5.7%.
Next payment due is actually only about 120 but im overpaying and i pay 600pm.
Im considering upping that in a couple of months to 1100 pm and once its paid off start making AVCs , so that im down that same amount. That would be around 30% or under of expected gross salary. I didnt make AVCs last year or this year.

Ill look into ARFs more and also need to look at funds my pension sits in. Keep meaning to do this but ill try prioritise that.

 

[dubdub123]

Do the maths of this make sense? I’m not sure TBH. I have €24 in my pension fund. I can withdraw €6 tax-free. I then stick that €6 into a new pension fund and it gets topped-up by €4 in the form of tax relief. So now I have €10 compounding away tax-free whereas previously I only had €6.

I guess if it’s the only way the person can afford to contribute to the new pension, it makes sense. But a better outcome would be to keep both working away in the pension funds.

I havent made AVCs last year or this year as trying to pay down non-mortgage debt first.. paid off car loan and overpaying on other loan. Ideally Ill get to a point of making AVCs to the 30% mark.
Taking that into account, might this make sense?

Any downsides to having the ARF kick in at 61 (except paying tax etc)?

This whole discussion is very interesting

 

[Redzer]

Do the maths of this make sense? I’m not sure TBH. I have €24 in my pension fund. I can withdraw €6 tax-free. I then stick that €6 into a new pension fund and it gets topped-up by €4 in the form of tax relief. So now I have €10 compounding away tax-free whereas previously I only had €6.

I guess if it’s the only way the person can afford to contribute to the new pension, it makes sense. But a better outcome would be to keep both working away in the pension funds.

I was contributing to my current pension but wasn't in a position to maximise my Income Tax Age limits. I had 4 older PRBs/PRSAs so had the flexibility to 'retire' one of them to benefit from the 40% tax relief on the lump sum. I may retire the others if I think that I'll be able to retire at 60 and any ARF imputed distributions will only be taxed at 20%.

Your example numbers are correct but didn't include a second tax relief boost when I also put the "€4" into my pension. I received another tax relief of "€1.6k" for that so now I have "€11.6k" compounding away tax free whereas previously I only had "€6"

 

[ashambles]

In the UK this is called pension recyling, it's allowed with restrictions.

Recycling tax-free cash or income

Techzone looks at the tax-free cash and income recycling rules and how they impact pension funding.

techzone.abrdn.com

"HMRC can impose a charge of up to 70 per cent of the value of your tax-free cash to prevent people from trying to exploit the rules and benefit from artificially high tax relief."

In Ireland I think there aren't explicit restrictions (yet - but even the existence of this thread increases the probability).

I suspect that it's only in recent years in Ireland that large number of people are starting to hit their 50's with reasonably sized DC funds (e.g higher skilled MNC workers hired in the 90's) - so it's not been a significant issue.

 

[Gordon Gekko]

In the UK this is called pension recyling, it's allowed with restrictions.

Recycling tax-free cash or income

Techzone looks at the tax-free cash and income recycling rules and how they impact pension funding.

techzone.abrdn.com

"HMRC can impose a charge of up to 70 per cent of the value of your tax-free cash to prevent people from trying to exploit the rules and benefit from artificially high tax relief."

In Ireland I think there aren't explicit restrictions (yet - but even the existence of this thread increases the probability).

I suspect that it's only in recent years in Ireland that large number of people are starting to hit their 50's with reasonably sized DC funds (e.g higher skilled MNC workers hired in the 90's) - so it's not been a significant issue.

They seem like very odd and discriminatory rules.

 

[Dr Strangelove]

In Ireland I think there aren't explicit restrictions (yet - but even the existence of this thread increases the probability).

I kind of doubt it

For the sums involved the anti avoidance measures would be very heavy and would likely have unintended consequences.

 

[ashambles]

I kind of doubt it

For the sums involved the anti avoidance measures would be very heavy and would likely have unintended consequences.

I think you're saying you doubt they'll introduce restrictions (rather than doubt Revenue currently don't/do have any restrictions)?

If so I suspect you're right - unless recycling is much more widely used or known about. But they could just copy some UK rules saying you when you can recycle and wouldn't need to expend too much effort on enforcement as most people with pensions would follow the rules as they'll be reluctant to put a pension at even a low risk of Revenue action.

If they push up the age people can access pensions that reduces the period when people can recycle. UK NMPA (national minimum pension age) has gone from 50->55 and is proposed to go to 57. (It's a bit surprising our age has stayed at 50)