Why is there an annual limit on pension contributions?

[Brendan Burgess]

This seems to be just taken for granted. I don't think it makes sense and should be replaced by an age related fund size.

The problem with this system is that if you don't use it one year, you lose it.

So for example, women who take 10 years out to look after their kids, lose 10 years of pension contributions.
Many people will have a much reduced income this year, and so will lose their opportunity to make contributions this year.

So why not replace it with a fund size - something like the following - these are purely illustrative figures to outline the concept. The maximum could be more or less than €2m.

If I want to prioritise saving for a house, I can do so without worrying that every year I am losing the opportunity to contribute to a pension.

If I have a very expensive time in my 40s due to college going children, I won't be penalised for stopping contributing to my pension fund.

And if someone is a low earner in their 20s and 30s but later becomes a high earner, they can catch up.

Brendan

 

[NoRegretsCoyote]

I think this is to allow people to "catch up" if they have neglected to make contributions early in life.

But TBH compound interest is a powerful force and we should really be incentivizing contributions earlier rather than later.


There is merit to a fund size approach, but this could penalise people when equities are having a good run.

Ideally people should contribute a stable fraction of their income, and from their mid-20s.

 

[Brendan Burgess]

compound interest is a powerful force and we should really be incentivizing contributions earlier rather than later.

As I am killed pointing out, it applies to mortgages as well.

We should be encouraging people to save - either through buying a home or through contributing to a pension.

And many people who are not paying tax at 20% in their earlier years have no incentive to contribute to a pension.

Brendan

 

[Brendan Burgess]

Ideally people should contribute a stable fraction of their income, and from their mid-20s.

Why?

1) In their 20s, people should be prioritising buying a house.
2) In their 30s, they might be maxing their pension
3) In their 40s, they might be paying for their kids education or taking a career break to retrain.
4) In their 50s, they might have nothing to spend it on and so should be putting a lot of it in a pension.

 

[NoRegretsCoyote]

Why?

Because they shouldn't be incentivized to over or under contribute because equity markets are doing badly or well. Over a working lifetime it averages out.

Because defaults are the key insight of behavioural economics. Once you step off the merry-go-round it's very hard to get back on.


Your proposal would encourage people to play around from year to year with their pension contributions. Most people don't have the financial literacy or willpower to do this.

As I am killed pointing out, it applies to mortgages as well.

True, but in the very long run the tax-relieved return on equities is likely to be higher than your mortgage interest rate.

 

[Brendan Burgess]

Because they shouldn't be incentivized to over or under contribute because equity markets are doing badly or well. Over a working lifetime it averages out.

My proposal has nothing to do with whether equity markets are doing badly or well?

Because defaults are the key insight of behavioural economics. Once you step off the merry-go-round it's very hard to get back on.

So, do you expect to spend the same default amount on your education, your housing needs and your family's needs throughout your life?

Sorry, but people's lives are just more complex than that.

Your proposal would encourage people to play around from year to year with their pension contributions. Most people don't have the financial literacy or willpower to do this.

I think you are making huge assumptions here. I don't think that most people play around with their finances. They would plan their house buying, their mortgage, their pension and their education costs in a coherent fashion rather than as 3 separate silos.

Brendan

 

[Marty39]

Yes this is a problem for myself and wife we are both on reduced working hours to care for young children , we don't have a pension we are early 40's. We won't be back working full time until youngest is 13 or so will be starting a pension at 52 or later before we are on high enough wage.

 

[Sarenco]

So why not replace it with a fund size - something like the following - these are purely illustrative figures to outline the concept.

Hi Brendan

What happens if my pension fund exceeds a relevant maximum fund size? Is there some sort of penalty?

And what happens if the fund subsequently falls below that relevant maximum fund size, due to market movements? Is the penalty reversed?

TBH I think you are trying to solve for a problem that doesn't really exit. The annual tax-relieved contribution limits are already very generous, particularly for older workers.

 

[Brendan Burgess]

What happens if my pension fund exceeds a relevant maximum fund size? Is there some sort of penalty?

No. Just no further contributions until the next age limit.

So, if at age 38, your fund suddenly increases in value to €550k, you stop contributing until you hit 40.

 

[Brendan Burgess]

TBH I think you are trying to solve for a problem that doesn't really exit. The annual tax-relieved contribution limits are already very generous, particularly for older workers.

Interesting. Whenever I suggest that people should prioritise their mortgage ahead of their pension, there is a chorus of disapproval on the basis of "use it or lose it".

I know business people who will have no income this year who maxed their pension contributions for the last few years.

Do you see any downside to the proposal?

Brendan

 

[NoRegretsCoyote]

My proposal has nothing to do with whether equity markets are doing badly or well?

Yes it does. If you are capping tax-relieved contributions on the basis of the size of your fund then a very good year for equities will see you lose the tax relief in the next.

This is the kind of complexity no one needs.

So, do you expect to spend the same default amount on your education, your housing needs and your family's needs throughout your life?

No.

But early in my working life I was in an actuarially very good DC scheme where I had no choice over my contribution levels. It was just another financial constraint and I planned around it when providing for family and buying a house. I certainly wasn't financially literate enough in my late 20s to go adjusting my contribution levels year by year. I'm quite thankful for the paternalistic planner who made sure I built up some good entitlements at a young age.

 

[Sarenco]

So, if at age 38, your fund suddenly increases in value to €550k, you stop contributing until you hit 40

Does this mean that I can make whatever contributions I like but no tax relief will be available in any given year if my fund has reached or exceeded €500k (on the last day of that year?) before my 40th birthday?

That would be gratuitously difficult to monitor/administer.

Whenever I suggest that people should prioritise their mortgage ahead of their pension, there is a chorus of disapproval on the basis of "use it or lose it".

That's certainly one argument for prioritising pension contributions over paying down a mortgage ahead of schedule.

But the more important point is that you would reasonably expect the returns on your (tax-relieved) pension contributions to comfortably exceed the interest savings on the mortgage over the long-term.

 

[Steven Barrett]

Why not?

Because it will be manipulated and abused by the wealthy. Company owners can pay themselves and their spouse €5,000 a year each and fund for a pension of €2m each.



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

 

[Brendan Burgess]

Because it will be manipulated and abused by the wealthy. Company owners can pay themselves and their spouse €5,000 a year each and fund for a pension of €2m each.

Hi S

They can do that now anyway. They must just do it over a longer period.

Self-employed people do have very volatile incomes. So if they use the good years to fund their pension, that it great.

Much better than blowing the money during the good years because they can't get tax relief on it.

The €2m figure by the way is for illustration only. The system of annual or age limits is independent of the limits.

If the final fund should be no more than €1m or €800k, the intervening amounts would be reduced accordingly.

Brendan

 

[Brendan Burgess]

Company owners can pay themselves and their spouse €5,000 a year each and fund for a pension of €2m each.

Is a company owner limited to the age related limits now? If they are abusing this at the moment, then maybe this should be addressed independently of my proposal.

Brendan

 

[Steven Barrett]

Is a company owner limited to the age related limits now? If they are abusing this at the moment, then maybe this should be addressed independently of my proposal.

Brendan

Hi S

They can do that now anyway. They must just do it over a longer period.

Self-employed people do have very volatile incomes. So if they use the good years to fund their pension, that it great.

Much better than blowing the money during the good years because they can't get tax relief on it.

The €2m figure by the way is for illustration only. The system of annual or age limits is independent of the limits.

If the final fund should be no more than €1m or €800k, the intervening amounts would be reduced accordingly.

Brendan

Thought you were referring to pensions in general. The same applies if just to the self employed. Reduce income down to the minimum and pile the rest into pensions.

Not all self employed have volatile incomes, lots of the professions can't incorporate (although they are finding ways to do so).

 

[Brendan Burgess]

Hi Steven

You are confusing me.

Am I right in saying that self-employed people and paye workers are subject to annual limits?

Company owners at present can get around these by letting the company make the contributions?

I am saying that the same rules should apply to all. A PAYE worker and a company owner should have age limits and not annual limits.




Brendan

 

[Conan]

Hi Steven

You are confusing me.

Am I right in saying that self-employed people and paye workers are subject to annual limits?

Company owners at present can get around these by letting the company make the contributions?

I am saying that the same rules should apply to all. A PAYE worker and a company owner should have age limits and not annual limits.




Brendan

Not quite.
The age limits really apply to personal contributions (self employed and employees) and to PRSA contracts.
In the case of Employees (whether “mere” employees or Directors) who are members of an Occupational Pension Scheme, the Employer/Company can contribute additional amounts over and above the employee contributions. These Employer contributions can exceed the Employee amounts. There is a limit on Employer contributions (complicated calculation but based on age, salary, anticipated investment returns and Revenue pension limits).
The same Revenue benefit limits apply to Employees and Directors, but if a Director only starts funding later in life (perhaps when the Co. becomes profitable), they can make up for years of no funding by making higher contributions in those later years.

 

[Brendan Burgess]

So Conan

In a word, what I am proposing already applies to a very large extent to people who own their own companies.

Whereas I have suggested a limit based on age, the existing limit is a bit more complicated

There is a limit on Employer contributions (complicated calculation but based on age, salary, anticipated investment returns and Revenue pension limits).

Brendan

 

[Conan]

So Conan

In a word, what I am proposing already applies to a very large extent to people who own their own companies.

Whereas I have suggested a limit based on age, the existing limit is a bit more complicated

There is a limit on Employer contributions (complicated calculation but based on age, salary, anticipated investment returns and Revenue pension limits).

Brendan

Ultimately the same Revenue limits on benefits apply whether you are an Employee or a Director. The only difference might be the pace of funding the benefits.
In the case of Self- Employed however, there is a limit on the contributions which qualify for tax relief. Technically there is no limit on the benefits.
All however are subject to the €2m limit on benefit value, with any excess being subject to an "excess of fund tax".