In the latest edition of Construction Magazine, Milestone Advisory’s Darragh Hogan writes that the adage, “Nothing is certain except death and taxes,” holds true. Especially when it comes to retirement. The good news is that with strategic planning, you can significantly reduce your tax burden in retirement by taking full advantage of available exceptions and tax reliefs.
Government Incentives: A Key to Future Savings
To encourage saving for retirement, the government offers valuable incentives in the form of tax relief. This is one of the most compelling reasons to contribute to a retirement savings plan, as other savings options do not receive such generous incentives. Contributions to a retirement savings scheme benefit from tax relief, typically at either 20% or 40%, depending on your income tax rate. Additionally, your pension investments grow tax-free, and you may receive a tax-free lump sum upon retirement. However, it’s important to remember that some taxes will apply to the income you receive from your pension after retirement.
The Inevitable Tax on Retirement Income
Retirement income is treated like regular income and is therefore subject to income tax. At Milestone Advisory, part of our role is to simplify the tax treatment of pensions, ensuring that our clients’ pensions are taxed correctly while maximising all available tax credits.
Retirement income can come from various sources, including pensions (guaranteed income for life), withdrawals from an Approved Retirement Fund (ARF), or Vested PRSAs. The Revenue Commissioners calculate the correct income tax rate for your pension, and life insurance companies must deduct income tax at the highest rate (currently 40%) until they receive a Tax Credit Certificate specifying the correct rate.
Additional Taxes to Consider
- PRSI: Annuity payments (guaranteed income for life) are exempt from PRSI. However, ARFs, Vested PRSAs, trivial pensions, and taxable cash payments are subject to PRSI Class S until age 66 (when you receive the State Pension).
- Universal Social Charge (USC): The USC is calculated on your full pension income. The rate you pay depends on your personal circumstances.
Timing is Everything: Drawing Down Your Pension
When you access your pension lump sum, which can be tax-free up to €200,000, the subsequent income from an annuity or ARF/Vested PRSA will be subject to tax. If you choose the ARF route, once you reach 61 years old, an imputed distribution is calculated as a percentage (currently 4%) of the ARF’s market value. This percentage increases to 5% at age 71. This minimum distribution is also subject to income tax.
It may be beneficial to delay accessing your pension fund. In the event of your death, an intact pension fund can pass tax-free to your spouse, assuming the related employment has ended. Conversely, an ARF can also pass to your spouse, but they will be liable for income tax on any withdrawals.
Managing Multiple Pension Pots
If you have multiple pension pots, consolidating them into one may not always be the best strategy. Having two or three separate pensions from different employments can provide flexibility, allowing you to access a lump sum from one while preserving another for later retirement.
For those with a defined contribution company pension, the retirement lump sum will depend on your specific circumstances and tenure with the company. In some cases, you might be able to avail of the one-and-a-half times salary lump-sum option, which could allow you to fully withdraw your pension fund without the need to purchase an annuity. This could be a strategic way to maximise tax savings on your pension.
Conclusion
Retirement planning involves not just saving, but also strategically managing how and when you access your funds. By understanding the tax implications and using available incentives, you can optimise your retirement income and reduce your tax burden, ensuring a more comfortable retirement.
Here to help you navigate your way to financial security.
The Milestone Advisory team are qualified financial services consultants. We specialise in helping professionals in the construction sector and related industries.
Our team will work with you to review your finances, explaining your options in clear English.
No jargon – just the facts.
For more information, contact Darragh Hogan (darragh@milestoneadvisory.ie).
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