Widow faces €300 tax charge for cashing in investment

I have a Bonus Saver account with Irish Life worth about €4,500. Necessity has caused me to cash it in.

I have now been informed that I will have to pay more than €300 exit tax. I'm over 70 years of age, a widow, and with only a widow's pension as a regular income. Is there any way out of this tax?

Ms JB, email

I’m not familiar with the bonus saver account but I am certainly familiar with exit tax. And I am afraid there is no escape for you, or anyone else drawing down funds from such investments.

Am I crazy to consider switching to an Ulster Bank mortgage?

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It can seem unfair when you are already on limited income with your widow’s pension and are only taking the money out because of necessity, but failure to charge you would mean the tax authorities getting no charge on profits you made in the fund, and that was never going to happen.

The concept of exit tax dates from the start of the millennium. Before then, fund managers such as Irish Life were required to deduct tax each year from any investments held by clients and pay it over to the Revenue.

These funds were known as net funds because your annual gain was always net of the 20 per cent standard tax on any gain that was paid to Revenue.

This didn’t suit the industry as it put more work on them. It was also argued, with justification, that it disadvantaged the customer because they did not get a chance to capitalise on the compound interest effect of rolling over their gains each year.

Persuaded, the government of the day introduced what was called gross roll-up and this is the system that remains in place today.

Under gross roll-up, you money stays invested year after year without any interference from Revenue. This gives you the opportunity to maximise your earnings – though clearly that’s only an issue when the fund is delivering successive annual gains. Still, it is a good idea and means you should get better returns from your investment.

For the industry, it had the advantage of reducing their administrative burden, and therefore their costs. That was a win for them, regardless of whether funds went up or down in any given year.

I’m not aware that any of these reduced administration costs found their way back into lower fund management charges – which would also have helped improve the customer’s performance. The scale of charges has always been a contentious issue in the Irish market.

Anyway, essentially the fund would be taxed when it matured or was drawn down. To compensate for the loss of annual tax revenue, a three percentage point surcharge was put on the tax bill on top of the standard rate of 20 per cent that would have applied under the previous regime.

So far, so good – but, as with so many taxes, a good idea can subsequently become an easy target for a cash-strapped government.

That 23 per cent tax rate on investment gains was in place up until the financial crisis, since when it has risen consistently. First, in 2009, the three percentage point surcharge became a six point charge.

The following year they did away with the notion of a surcharge on the standard tax rate and put a new flat rate of 28 per cent in place. That jumped by two to five percentage points every year until 2014, by which time exit tax was taking 41 per cent of your gains.

And while it was originally charged only on maturity, in 2006 the Government introduced new rules on taxing such funds every eight years, regardless of whether any money was drawn down or at maturity, whichever is the sooner. This was done in an effort to address tax avoidance, with such funds having become a valuable "tax planning" tool – that is, a way to avoid tax.

None of which will save you any money in your position but it does at least explain why you have faced this charge.