Budget Update 2011
Construction Federation Executive Pension Scheme Budget & Regulatory Update 2011
1. Reduced tax relief on member contributions
In 2010 and previous years members received tax relief on the full amount of their personal contributions including additional voluntary contributions (subject to certain Revenue limits) at their highest marginal rate of tax. In addition, members received relief from PRSI and the employee health contribution at their marginal rate (8% if annual earnings were less than €75,000 or 5% if annual earnings were more than €75,000).
With effect from January 2011 relief from PRSI and the health contribution has been removed. In addition it is now proposed that:
- With effect from January 2012 the maximum rate of tax relief will reduce from 41% to 34%
- With effect from January 2013 the maximum rate of tax relief will further reduce from 34% to 27% and
- With effect from January 2014 tax relief will be limited to the basic rate of income tax of 20%.
The effect of this will depend on individual circumstances. The following table illustrates how the net of tax cost of a member pension contribution of €100 will increase if these proposals are implemented.
|Net cost of pension contributions of €100 in||Assumed tax rate 20% assumed PRSI rate 8%||Assumed tax rate 41% assumed PRSI rate 8%||Assumed tax rate 41% assumed PRSI rate 5%|
2. Lower limits on tax deductible member contributions
As well as reducing the effective rate at which tax/PRSI relief is provided the maximum tax deductible contribution has also been restricted. The maximum tax deductible contribution depends on age and earnings as follows:
|Age attained in tax year||Maximum tax deductible contribution as % of earnings|
|Up to 30||15%|
|30 to 39||20%|
|40 to 49||25%|
|50 to 54||30%|
|55 to 59||35%|
In 2010, the maximum tax deductible contribution was calculated by applying the relevant percentage to an individual's gross taxable earnings up to an earnings limit of €150,000 per annum. With effect from January 2011 this earnings ceiling has been reduced to €115,000 per annum. For example, in the case of a member who reaches their 43rd birthday in 2011 and who is earning more than €115,000 per annum the maximum tax deductible contribution (inclusive of AVCs) is now €28,750 i.e. 25% x €115,000.
3. Taxation of retirement lump sums
On retirement, members may currently receive a tax free retirement lump sum of up to 1.5 times annual earnings (assuming they are retiring at their normal retirement age having completed at least 20 years service with their employer). For this purpose, annual earnings averaged over any 3 consecutive years in the last 13 years prior to retirement may be taken into account. This maximum lump sum is inclusive of any lump sums which a member receives from other pension schemes.
With effect from 1 January 2011 such retirement lump sums will only be tax free up to €200,000. Lump sums between €200,000 and €575,000 will be taxed at the basic rate (currently 20%) and lump sums in excess of €575,000 will be taxed at an individual’s marginal rates. The overall limit of 1.5 times annual earnings will also be retained.
If members are currently paying Additional Voluntary Contributions to fund a tax free retirement lump sum they may now wish to review these arrangements. In this regard they should consider the effective rate of tax relief being obtained on AVCs and the rate of tax likely to be payable on any lump sum funded from these AVCs.
4. Reduction in lifetime pension limit
The lifetime pension limit is the maximum total benefit which an individual may receive from all tax approved pension arrangements (including the pension plans of previous employers). Previously, the lifetime limit was approximately €5.4m (or such higher sum as may have been claimed from the Revenue in 2006). For this purpose, the value of an individual’s pension entitlements is calculated as the sum off:
- The amount of any pension payable from defined benefit pension schemes multiplied by a factor of 20 plus
- The value of a member’s AVCs plus
- The value of a member’s retirement account under any Defined Contribution schemes.
The amount of the lifetime limit has been reduced to €2.3m with effect from 7 December 2010 (budget day).
If the value of a member’s benefits already earned up to 7 December 2010 is greater than €2.3m the member can apply to the Revenue for a personal lifetime allowance equal to the value of benefits earned up to 7 December 2010 but no greater in any event than the previous limit of €5.4m. For example, if an individual has already earned benefits valued at €3.5m up to 7 December 2010 then the lifetime limit for that member is €3.5m providing the higher personal allowance is claimed from the Revenue by 6 June 2011.
On retirement, if the value of a member’s pension scheme benefits exceeds the available lifetime allowance, the excess will be subject to an effective rate of taxation of the order of 70%. This arises because the excess over the lifetime limit will be taxed at the point of retirement (currently at 41%) and will then be taxed again when the benefits are drawn from the pension scheme. It is therefore normally in the interest of members to ensure that their benefits do not exceed the available lifetime allowance and they should obtain personal financial advice if they believe they may be affected by these provisions.
5. Approved Retirement Funds
On retirement, members may currently transfer the value of their additional voluntary contributions to an Approved Retirement Fund (ARF). An ARF is an individual investment plan through which members may continue to hold the accumulated value of their AVCs following retirement. Withdrawals from an ARF may be made at any time during a member’s retirement and such withdrawals are taxed in the same way as pension payments. Under current Revenue rules individuals are deemed to withdraw 3% of the value of their ARF each year for taxation purposes (which for practical purposes means that they must withdraw at least 3% of the value of the ARF each year). The level of deemed withdrawal has now been increased to 5%.
There is some good news for members of Defined Contribution sub schemes. Until now, they were only permitted to use the ARF facility in relation to assets funded from AVCs and were obliged to use the balance of their retirement account to either provide a lump sum or buy a pension annuity (this restriction did not apply to proprietary directors who, subject to certain conditions, could use the ARF facility in relation to all of their retirement account). The ARF facility has now been extended to all DC assets. This means that DC members (who are not proprietary directors) will no longer be obliged to buy annuities on retirement. However, members will only be able to invest in an ARF if they have guaranteed pension income for life of at least €18,000 per annum (including the State Pension). If a member does not satisfy this income requirement then an amount of €120,000 must first be invested in an Approved Minimum Retirement Fund (where withdrawal of the capital originally invested is not permitted until age 75) and only the balance may be transferred to an ARF.
6. Increase in State Pension Age
The Government has confirmed that legislation to increase the minimum age at which members may receive a State pension will be introduced during 2011. Currently, an individual who has ceased working may receive a State pension at age 65. This age is being increased on a phased basis as follows:
|Year of birth||New State Pension Age|
|1948 and earlier||No change|
|1949 – 1954||66|
|1955 – 1960||67|
|1961 or later||68|
For example, if a member was born in 1958 their State pension age will now be 67 and if they were born in 1968 their State pension age will be 68.
7. Introduction of Employers PRSI changes on 50% of member pension contributions
With effect from January 2011 employers will be required to pay PRSI on 50% of member pension contributions (including AVCs). Previously, the employer paid no PRSI on that part of an employee’s earnings which was paid to a pension scheme as member contributions. This is effectively a halving of the relief from Employer’s PRSI on member pension contributions which previously applied.
8. Some positive news!
Apart from the extension of ARFs to all DC members it should be noted that:
- There is no current proposal to tax investment returns on pension funds which will continue to be exempt from income tax and capital gains tax and
- There is no current proposal to tax employer pension contributions as a benefit in kind
9. Further information and action points
Members are strongly recommended to obtain their own personal financial advice in relation to these matters. In the case of members with accrued benefits in excess of €2.3m at 7 December 2010 the importance of ensuring that the appropriate allowance is claimed from the Revenue by 6 June 2011 cannot be over emphasised.
It should be noted that contributions paid by an employer on a member’s behalf continue to obtain full relief from income tax and levies and remain a very tax efficient element of an individual’s remuneration package.
Members should also be aware that there is a final opportunity to obtain tax relief at above the basic rate on contributions paid prior to 2014. Members may therefore wish to consider accelerating the payment of future AVCs. In this regard, it should be noted that members may still pay and obtain tax relief on contributions in respect of 2010 providing these contributions are paid and tax relief claimed prior to the date on which an individual submits their 2010 tax return (although such contributions will be subject to the €115,000 earnings limit).
Should you require any further information in relation to this matter please contact The Construction Federation Executive Pension Scheme on 01 4071430 or firstname.lastname@example.org. The services of the Scheme Actuary (Towers Watson) are available to employers should assistance be required in relation to the making of an application for an increased personal lifetime allowance in excess of the new standard allowance of €2.3m. Employers who require such assistance should contact James O’Connor of Towers Watson at 01 775 6725. The cost of this service will be the responsibility of the participating employer.
It should be noted that some of the measures described in this letter (e.g. the reduction in tax relief on pension contributions to the basic rate) represent current Government policy which may change before these measures are implemented.