S&P 500 ETF or tracker without 41% tax hit

Hello,

Excuse my ignorance on pensions etc.

I'm a 55 year old Brit living in Ireland who is interested in consistently investing in the S&P 500 over the next 10 years, assuming i live that long.
Probably max 20k per annum.
41% tax seems extortionate.

I'm thinking that I cannot get a UK ISA even with someone holding Power of Attorney for me? Is that right? I still have a UK bank current account.

This leaves a Personal Pension.
I believe there is no CGT on an ETF or tracker within a pension, but what sort of tax are you looking at when it's time to withdraw the funds?

And total fees and tax in general, compared to say a Vanguard standalone S&P500 ETF?

Thanks for any help

Billythebuilder said:

I'm thinking that I cannot get a UK ISA even with someone holding Power of Attorney for me? Is that right?

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Yes, it is. Or, more accurately, it might be possible to get one but it won't enjoy any tax advantages or exemptions in Ireland, the country of your residence.

Billythebuilder said:

This leaves a Personal Pension.
I believe there is no CGT on an ETF or tracker within a pension, but what sort of tax are you looking at when it's time to withdraw the funds?

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There's not only no CGT, but no income tax or tax of any other kind, on the earnings from assets held within a pension fund.

On withdrawal, you can generally get 25% of the accumulated fund totally tax-free. That's capped at €200,000 but, on contributions of €20k/year for 10 years, you're not likely to accumulate a fund of €800,000, so the cap shouldn't bite in your case.

The balance has to be taken as income and is taxed as income at your marginal rate which, depending on your cirumstances when you're 65+, will be 20% or 40%.

Which means:

• If you're paying in the 20k/year out of already-taxed income this is a bad deal. You'll be subject to income tax twice; once when you get the money that you contribute to the pension plan, and a second time when you take (75% of) the money out of the plan. This double taxation will more than offset the benefit of any tax-free earnings within the fund. So don't do it. You'd be better off investing in an ETF outside the pension fund structure and just suffering the 41% exit tax on earnings.
• But, to the extent that you currently have income against which you can claim a tax deduction for pension fund contributions, this is a very good deal. At 55 you can contribute up to 35% of your earnings to a pension plan and claim a tax deduction for that; from age 60 that goes up to 40%. So unless you have no, or pretty low, earnings (i.e. you're already living off investment income and the like) you should have scope to contribute much, and possibly all, of the 20k/year to a pension plan and claim a deduction for it. The outcome for you will be vastly better than investing in an ETF outside the pension fund structure just suffering the 41% exit tax.

Billythebuilder said:

And total fees and tax in general, compared to say a Vanguard standalone S&P500 ETF?

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The fees hardly matter in the scheme of things, to be honest. You can (and should) look for a low-cost pension plan that doesn't take a skim off the contributions you put in, and that limits its annual charge on the funds invested to below 1%. The tax advantages that you will get from investing though a pension plan will hugely outweigh the impact of charges of that kind.

The main thing you need to be aware of is that, once you put the money into a pension plan, there are rules about when, and how, you can get it back out again. Basically, the trade-off for the tax advantages is accepting restrictions on access. Broadly speaking, the restrictions are designed to make it easy to access the money to provide income in older age, but difficult to access it for other purposes. If that aligns with what you actually intend to do with the money, you may be happy to accept the restrictions. But do think through what happens if your plans or circumstances change.

Fantastic reply. Thanks very much.

Quote :"So unless you have no, or pretty low, earnings (i.e. you're already living off investment income and the like) you should have scope to contribute much, and possibly all, of the 20k/year to a pension plan and claim a deduction for it. The outcome for you will be vastly better than investing in an ETF outside the pension fund structure just suffering the 41% exit tax"

I'm abit of a dummy with pensions, so just to be clear, a tracker or ETF , within a pension is not as good as a standalone 41% taxed ETF, but is better after you get tax deductions? Did I understand that correctly?

What about personal pensions vs employment contribution pensions in this case?

Thanks a mill.

Billythebuilder said:

I'm abit of a dummy with pensions, so just to be clear, a tracker or ETF , within a pension is not as good as a standalone 41% taxed ETF, but is better after you get tax deductions? Did I understand that correctly?

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It's the same tracker/ETF basically. The difference is that if you invest directly, you suffer the 41% exit tax on growth within the fund. But if you give the money to your pension fund provider and they invest in the same tracker for you, they don't suffer the exit tax. (And nor do you, when the money comes out of the pension fund and back to you.

A little worked example to highlight the differences. You've got €1,000 to invest for 8 years. You like the Whizbang ETF. Your marginal rate of income tax is 20%

Option A: You invest directly

• You put €1,000 into the Whizbang ETF.
• Over the eight years, the Whizbang EFT grow by 50%. So now you have €1,500.
• You take the money out. The growth in the fund, €500, is taxed at 41% — that's €205
• So after 8 years you end up with €(1,500 - 205 =)1,295

Option B: You invest through a pension plan.

• You put €1,250 into the pension fund. You claim a tax deduction for €1,250 and so your taxable income is reduced by that amount. Your tax bill is therefore €(1,250 x 20% =)250 lower. So the net cost to you is €1,000.
• Over the eight years, the Whizbang EFT grow by 50%. So now you have €(1,250 x 150% = )1,825.
• You take the money out. No exit tax, but instead:
  • You get 25% — that's €456 — tax free.
  • The remaining 75% — that's €1,369 — is taxed at 20%. So the Revenue Commissioners take €274.
• The upshot is that you get €(1,825 - 274 =)1,551.

You can see that option B is much better. Option A gives you a return of €295; option B gives you a return of €551 — going on for twice as much.

(And, if you're a 40% taxpayer now, then under option B you could put €1,667 into the fund to begin with, for an net cost to you of €1,000. But in 8 years time, when you've retired, your tax rate might be down to 20%. If that was the case, it would make option B even even better.)

These calculations ignore the charges the pension fund makes. But say the pension fund charges you 1% of fund value each year — that means they take €12.50 in the first year (because you put €1,250 into the fund); a bit more in the second year (because the fund has grown a bit); and so on. The net effect of this is that you won't get 50% growth within the fund; it will be reduced by the pension fund charges.

I'll spare you the maths, but in this particular example the effect of a 1% annual management charge in the fund would reduce the growth over 8 years from 50% to 39%. That would mean that instead of €1,825 in the fund after 8 years, you'd have €1,737. And after the Revenue had taken their tax of 20% of 75% of that, you'd have €1,477 in your hand; still miles better than €1,295.

Thanks again.

Billythebuilder said:

Quote :"So unless you have no, or pretty low, earnings (i.e. you're already living off investment income and the like) you should have scope to contribute much, and possibly all, of the 20k/year to a pension plan and claim a deduction for it. The outcome for you will be vastly better than investing in an ETF outside the pension fund structure just suffering the 41% exit tax"

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Just for your information...

Billythebuilder said:

I'm abit of a dummy with pensions, so just to be clear, a tracker or ETF , within a pension is not as good as a standalone 41% taxed ETF, but is better after you get tax deductions? Did I understand that correctly?

Click to expand...

The first question to answer here is: do you have an employment on which you pay Irish income tax? If the answer is yes, broadly speaking, the pension is the better option.