Key Post Should you contribute to a pension fund if you are in danger of breaching the €2m limit?

What is the Standard Fund Threshold? In summary, it's the €2m cap placed on the public or private sector pension benefits that an individual can accumulate in Ireland over his or her lifetime.

If the individual breaches the SFT, at the point the offending pension benefits are retired, he or she is subject to a penalty tax (Chargeable Excess Tax) on the surplus amount.

The issue I'd like to focus on is how individuals should plan their investments in the context of the SFT.

Breaching the SFT isn't a particularly attractive proposition (or is it; we'll come to that later). Say your benefits are worth €3m; the State rides in and grabs 40% of your €1m excess (€400k). You then get your lump sum (€500k, net €440k), with the balance (€2.1m) moving into your ARF/AMRF.

(I've restricted the discussion to DC schemes and ignored the annuity route.)

The €1m excess is therefore taxed once at 40% and then taxed again as it is withdrawn from the ARF. People often talk about an effective rate of 70%, although I have reservations about the logic of that.

It therefore creates a conundrum for a person who cannot access his/her benefits and who will breach €2m/€2.15m (a quirk effectively makes the cap €2.15m but for the purposes of the discussion, let's call it €2m).

So what should that person do?

- Aim to breach €2m in the hope that the SFT rises?
- Aim to get to €2m and then switch to cash because the risk/reward is so unattractive?
- Aim to breach €2m, convert €2m to cash and take high risk/high payoff bets with any excess?
- Grow their pension without a care in the world, because (using the €1m example) a €400k penalty is fair value for having €600k invested in a tax-free environment for circa 30 years.

It's an interesting topic in my view.

The actual tax rate on drawdown will depend on the tax rates at the time, but it's clear that the tax on any pension fund in excess of the €2.15m will be in the order of 70%.

Hi Gordon

There's a tax credit in there somewhere regarding the tax paid on the lump sum and the tax paid on chargeable excess. I'll have to root it out as I can't remember exactly how it works. I'll be back to you on it.

Steven
http://www.bluewaterfp.ie (www.bluewaterfp.ie)

This article from Davy discusses the available strategies for dealing with the SFT issue.

Sure.

Everyone talks about €2m.

But if you have €2.15m, you end up with a 40% chargeable excess tax liability on that €150k excess, i.e. €60k.

However, separately, on your €500k lump sum, you pay €60k of income tax (€200k tax-free, €300k taxed at 20%).

The €60k on the lump sum is available as a credit against the €60k of chargeable excess tax.

So no chargeable excess tax.

Makes the threshold €2.15m in reality which is handy additional headroom for marginal cases.

It makes sense to turn down the investment risk once you reach the limit for the reasons outlined above however should you still contribute to a pension if you are above the limit?

Say you had 100k in a company that had to be put in a pension or taken as salary. Id be inclined still to put into the pension. What would you do?

Fergal19 said:

It makes sense to turn down the investment risk once you reach the limit for the reasons outlined above however should you still contribute to a pension if you are above the limit?

Say you had 100k in a company that had to be put in a pension or taken as salary. Id be inclined still to put into the pension. What would you do?

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I would be inclined to take the €48,000 Net now as opposed to putting in €100,000 into a pension pot that has gone over the cap. You will automatically be taxed 40% on it and have further tax on drawdown. Over simplification of it but if you were to take all your pension minus the taxes at the earliest possibility you would end up with about €36,000 on the €100k you put in

Fergal19 said:

It makes sense to turn down the investment risk once you reach the limit for the reasons outlined above however should you still contribute to a pension if you are above the limit?

Say you had 100k in a company that had to be put in a pension or taken as salary. Id be inclined still to put into the pension. What would you do?

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I’d hire my wife on a salary that is reasonable and put the €100k into a pension for her.

Every individual has his or her own €2.15m threshold.

Gordon Gekko said:

I think with €1m at age 50, I’d keep contributing with a view to getting to €2.00m/€2.15m and then switching to cash (and ceasing contributions).

I think the trick is to get into an ARF as soon as you hit €2m if possible.

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Can you expand on why to get it into an ARF asap?

And thank you for creating this valuable thread!

SPC100 said:

Can you expand on why to get it into an ARF asap?

And thank you for creating this valuable thread!

Click to expand...

Hi,

Well it’s primarily because everything above €2.15m is subject to 40% penalty tax and still trapped inside a pension structure.

So if I’m threatening the threshold, it makes a lot of sense for me to move into an ARF where I get 25% of the value and the other 75% can grow unencumbered.

Thanks!

But, the ARF has the drag factor of the imputed distribution (currently 4% or 5% depending on age) but your ARF could (depending on sequence of returns and returns) grow back to over the 2million without suffering from SFT.

It appears the only other point to be aware of is that you might jump to a 6% imputed distribution
"The imputed distribution at all ages over 60 is 6% for those with ARF assets and vested PRSAs worth over €2 million." from [broken link removed]

I wonder are there any cases where the imputed distributions could fare worse than the penal tax.

OK

I have tidied up this important thread to remove some of the distractions.

It's clear that once you breach the €2.15m you should not contribute any further.

You should take 25% of it and put the balance into an ARF. What is the earliest age you can do that?

What if your employer is still contributing to the scheme? Do you try to negotiate with them to pay you the pension contribution as gross salary instead?

What if you have €1m at age 50 and plan to retire at age 65?

A 5% return without any further contributions will bring you to €2m at age 65.

Should you just pause any further contributions to see how things go?

The fund might crash in value over 5 years, and so you might start maxing your contributions again.

What if you have €1.8m at age 63 and the stock market is depressed?

It could easily jump 20% in two years and you end up with penal tax on the surplus.

Or it could fall by 20% and leave you with unused scope for tax-relief.

Brendan

50 is the earliest that you can “ARF”, but it necessitates leaving the related employment and for a company owner it means selling one’s shares.

Brendan Burgess said:

What if you have €1m at age 50 and plan to retire at age 65?

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I would have thought that the appropriate approach would be to keep contributing to the fund as before, perhaps gradually lowering the allocation to equities somewhat.

If you find yourself in the fortunate position of hitting the €2.15m mark early, you can simply go to cash until you are in a position to take the 25% lump sum and transfer the balance to an ARF (which you can invest however you see fit).

I really don't see this as a major problem.

And if an Employer is contributing, then it probably makes sense to keep accumulating even if this exceeds the €2.15m.

Conan said:

And if an Employer is contributing, then it probably makes sense to keep accumulating even if this exceeds the €2.15m.

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I wouldn’t have thought so. Better to just take extra salary, if your employer allows it.

I think the pension option should be the preferred choice even if above the limit and the contributions will be subject to the CET. I don't understand why it is so clear to stop funding the pension.

For example look at a 100k contribution to a pension vs a 100k in salary payment. After the CET there will be 60k in the ARF. Now this will be subject to the drawdown say at 4%. So gross drawdown of 2400 with circa 1200 in tax and 1200 in net income. This however can be offset by say 4% growth in the fund annually. So at the end of the year the ARF is worth 60k and I have 1200 in my personal bank account. In effect this happens each year with my personal bank account increasing by 1200 and the ARF balance staying at 60k. In essence the tax of this option is the 40k CET?

If I take it as income I will have 48k net. Invest this again at say 4%. We will say income generating assets so this will be a net 2% growth annually or 960. So here I have 48k and my personal bank account is increasing by 960 each year. Again in essence the tax of this option is the 52k PAYE?

In option 1 I have paid 40k tax, receive an amount of 1200 annually and have a 60k asset while in option 2 I have paid 52k tax, receive amount of 960 annually and have an asset of 48k.

Surely this means that the pension is still the way to go even above the 2.15m limit? Am i missing something?

Also there is a 10.75% employer PRSI saving with the pension option.

Finally if we delay crystallisation of the pension we get to invest the CET at 4% tax free. This growth further reduces the effective tax rate.

Business owners will also have the CGT option to consider.

Very interesting analysis Fergal19. However, you are not comparing like with like. It’s €48k in one’s back pocket versus €60k trapped in an ARF. That’s the key point.

But is it not just an asset either way?

The majority of ARF holders wont or don't want to "untrap" their ARF. This is especially the case for people that are at the maximum limits. Ultimately it just forms part of their estate so I don't understand the "trapped" logic.