Maximum Funding

Is it now time to act?

Is it now time to act and advise your clients to maximum fund their pensions or are we no closer to seeing changes to the tax reliefs available to pension savers?

For years now we have heard murmurings about a change to the pension tax relief system in Ireland with nothing coming to fruition.

The arguments both for and against changes to the current tax relief system have been considered but no changes to the current system have been proposed. That doesn’t mean to say though change isn’t on the horizon. We would have to think that one of the key drivers will be the introduction of Auto Enrolment pensions in Ireland as government is more than likely going to standardise the pension tax relief at that point. Another possibility is that the current pandemic and the impact it is having on State finances will force government to reduce tax relief's available or cap large employer contributions.   

Occupational pension schemes are one of the most tax efficient ways of providing pension benefits for Schedule E company directors and employees. This is because employer contributions can be written off against corporation tax as a business expense and are not treated as a benefit in kind for the employee.

There are Revenue limits on the maximum pension that a scheme member can have, which means there is a maximum fund that can be accumulated to reach this target pension.

I want now to look at the concept of maximum funding. If someone asked you to explain the concept to them would you be able to?

In simple terms you are looking to get the cost of the Revenue maximum pension at normal retirement age by applying a factor to the pension to turn it into the estimated fund to buy that pension, next take into account all existing pension funds and lastly work out how much needs to be contributed on an annual basis so as to reach that maximum fund at normal retirement age. This amount is the maximum annual contribution allowable to the occupational pension scheme.

The maximum pension is typically a pension of two-thirds of salary on the basis the individual has 10 years or more service with the employer at normal retirement age.

There are numerous online funding calculators you can use that will tell you the maximum allowable pension contribution but it is important you don’t rely on them as they don’t tell the full story. It is widely accepted industry practice that within 5 years of normal retirement age you can use current annuity rates and this is where the funding picture really changes. The reason for the 5 year timeframe is that this is in line with the guidance from the Society of Actuaries in Ireland where you use current annuity rates in pension projections where the term to retirement is less than 5 years.

I’ve set out some examples in the table below to show you how the funding position changes dramatically if you use current annuity rates instead of the Revenue capitalisation factors. It is based on a married individual earning a salary of €75,000 a year, so a pension of €50,000 a year (two-thirds of salary as greater than 10 years service at normal retirement age):

The annuity rates are based on a pension with a 10 year guarantee period, increasing at 3% per annum and a 100% spouse’s pension where the spouse is the same age as the main life. The current lifetime pension fund limit or Standard Fund Threshold (SFT) for an individual is €2 million.

Contribution Types

There are two types of allowable contributions that can be paid into a scheme-Ordinary Annual contributions and Special Contributions.

• An Ordinary Annual Contribution is the maximum contribution a company can make to fund ongoing and get tax relief in the company tax year it is paid. It can be paid into a scheme on a regular basis (monthly, quarterly, half yearly or yearly) or by way of a single contribution top up.

• A Special Contribution is used to provide benefits on behalf of unfunded past service with an employer and is normally paid as a single contribution top up.

The generous limits of maximum funding shows the importance of questioning the funding   position under a clients pension as there may well be plenty of scope to fund where at first look that isn’t obvious.

Take action now it may be only a matter of time before we see change.

Kind Regards,

Anne O'Doherty