Married, Single income retirement planning

Hi, couple looking to retirement <10 yrs time. I'm in public sector, with DB scheme (pre-1995) so can go at 60 w/ 38y service and pension of ~€50k w/ lump sum. No complaints. However, OH is disabled and never worked so no entitlements/pension. Job is stressful so hoping to go earlier using notional service or AVCs. However, regardless, I see little tax benefits as being married, single income means hitting marginal rate at ~€44k so even in retirement, anymore above that has 40% tax & USC, negating the tax benefits going in. Though buying notional service would let me go early (say, 58), the cost is €50k net of tax relief and it would appear to me to take min. 16y to regain that investment on retirement - particularly given paying marginal tax rate on that pension income. Am considering small AVC to help meet Revenue's 1.5x of final salary to max the lump sum.
I have decent cash reserves (~€100k), no debts, own home, kids nearly fully raised and secure. OH would welcome better pension (for security) but tax treatment puts me off investing more (even for early retirement). There may also be health issues on the horizon so an early exit is inviting. Lifestyle is not at all extravagant so I reckon ~€46k pension is more than adequate. Any ideas?

My retired parents earn approx 50k across several incomes, including small State Pension to mother who was mainly a SAHP.

Their SRCOP is approx. 44k plus the 10k State Pension, so about 56k.

However, note that their effective tax rate on the 50k is under 10%.

Effective tax rates are well below marginal tax rates for most people.

@Protocol Thanks for the post as I've found it hard to estimate net pay when retired - can't find good calculators. However, our income would be solely mine so €44k SRCOP. I don't see our tax treatment changing until 66 (when PRSI drops away) so the tax relief of upping my pension contribution is cancelled out later (plus USC). When I put €46k pension income into tax calculator, I do get ~12% effective tax rate but there is exposure even at that point to marginal rate so not convinced it's worth upping my contributions to have them taxed at >40% later. Or am I asking too much?!

Hi

I posted this previously on a similar query, my reading of the attached article suggests it's definitely worth maximising contributions now if a higher rate tax payer.

50andOut said:

Hi

The below article makes for interesting reading when looking at effective tax rates:

But Pensions Get Heavily Taxed in Retirement, Right?...Wrong! - The Pension Store

Did You Decide Against Starting A Pension Because of The Income Tax You Pay in Retirement? The Actual Amount You Would Pay Is Way Less Than You Think.

www.thepensionstore.ie

So assuming you are higher taxpayer :

40% tax relief on the way in
TAX free Growth
25% drawdown with the first 200k tax free and the remainder at 20%
The remaining ARF Payments being drawdown at a max of 23% Effective rate as per the above article

Its a no brainer to not maximize your contributions and attain the highest pot possible.

50+0

Click to expand...

This is misleading. The issue is not the “effective rate of tax” it’s the “marginal rate of tax”.
Yes it is tax effective to maximise your lump sum on retirement (particularly the tax free amount up to €200,000). But investing AVCs, even where you get tax relief at 40% on the way in, but where the extra pension income is going to be taxed at the marginal rate (40% + 4%) makes little sense.
If all the AVC fund can be taken as an additional tax free amount, that’s a great deal. If any excess AVC fund (over and above any additional lump sum) has to be used to generate an income (whether from an ARF or an Annuity) and the additional income is only going to be taxed at 20% (plus USC), that’s a good deal. But if the additional income is going to be taxed at a rate higher than the tax relief on the contributions, then that makes less sense.

Hi Conan

Can you elaborate with an example on how its misleading (exclude the TFLS and tax free growth) ?

I like the article as its simple and straightforward for my head to grasp but am interested to learn its shortcomings / adjust my reading of it.

e.g.
If my future pension income is estimated now at €4k per month (10% effective rate per the info) why would I not continue adding to my AVC's with relief at 40% to raise the amount to €5k per month (raising future effective rate of tax to 16% per the info).

tnx
50+O

Because the extra €1,000 per month will be subject to tax at the higher rate ,even if the total income might only be subject to 16% tax.
Example
If the pension income was say €36,000 and thus below the tax threshold (no Income Tax) and your AVC fund generated an additional €1,000 income, that €1,000 will be taxed at the higher rate. So thought the total tax bill will be only €400 (effective tax rate of 1%), the marginal rate is still 40%. So any additional income over the threshold is taxable at the higher rate, thus negating the contribution tax relief.

@Conan Yes, that's the key point. I can invest ~€9k in AVCs with a view to using it only to add to my lump sum for the small amount it's shy of the 1.5x Revenue limit. @50andOut did highlight that from 65 I can have €36k income in retirement with no income tax. However, it's the fact that upping my contributions to generate a greater income beyond this only leads to that extra being taxed at 40% later (from 65) and before that age, even more.

Ok so if I looked in isolation at the point just above/below the cut off rate threshold as it stands today, the incremental gain over that point gets a marginal rate of 40%. I get that, however this assumes the threshold doesn't increase, which it will and it also ignores the available tax credits, which reduces the €400 tax bill

The effective tax % makes much more sense in evaluating the overall impact of what a higher pension pot will mean to me in real terms.

(Again ignoring the TFLS and Tax free growth which in any event has a material effect on my continued belief it makes sense to maximise AVC's).

I'll assume from the original post that the cost of retiring early is too high and is being ruled out.

Raisinette's pension will be €46,000 per year as it stands. This alone will use up all tax credits and 20% tax band. So any additional income in retirement will be subject to 40% tax plus levies. Personally I wouldn't bother. Get 40% tax relief on contributions. Pay 40% tax on the proceeds PLUS levies.

There's a small gap to use AVCs to boost the tax-free lump sum up to Revenue limits. This should be definitely done and no more, in my opinion.

Counter-arguments:

• Tax-free growth on AVC funds. How much difference is this likely to make over an investment period of <10 years? What happens if raisinette goes for a cautious fund with modest growth if any? To what extent will AVC product charges swallow this tax advantage anyway?
• Maybe the 20% rate band will increase by the time raisinette retires. Maybe it will; maybe it won't. I can't see too many giveaways in the next couple of budgets following Covid but who knows after that? I wouldn't be so confident about it as a possibility as to start shovelling money into an AVC now.

Although I spend most of my working hours extolling the virtues of putting as much as you can into a pension fund, in this instance my feeling would be that your disposable money would be better served by investing it elsewhere to supplement your funds in retirement. While you say that OH would welcome a better pension for security, my guess is that simply having a bigger balance of savings would also add to the feeling of security.

Regards,

Liam
www.ferga.com

Using AVCs to maximise any shortfall in the main scheme tax-free lump sum makes absolute sense. I have always argued that point on this site.
However the “tax free growth” is more problematic:
- growth is not guaranteed
- investing AVCs with a relatively short period to go more often involves adopting a low risk strategy. This may result in little or no growth. Typically older AVC investors are reluctant to take investment risk in the hope of a better return.
- investing AVCs above that used to generate a higher lump sum, even with tax relief at 40% and the possibility of some investment growth, only to have the additional retirement income taxed at 44% makes little sense.

In my opinion, it’s the “marginal rate of tax” that’s most important when investing AVCs beyond the tax-free lump.

@LDFersuson,
well summarised but if I were to setup a PRSA separate to the work PS occupational scheme, could I not withdraw 25% of the pension as tax-free lump sum at some later point? Or is this limited to 1.5x final salary as per my occupational PS scheme? As I read it, I'm capped at 25% of private pension fund (25% of that fund won't exceed €200k).

As for investment horizon, I may not need to dip into this plan for 15yr or more as my work pension+lump sum would probably suffice meantime. It's more about minimising my marginal tax exposure in my final years of work.

As you say, I'll likely be hitting marginal rate on work pension but is there scope to squirrel away some spare cash now and avail of the generous tax relief? I assume if I die any PRSA pension would pass to my spouse? The work pension, I know, is halved to surviving spouse.

Regards,
R