Pensions the most tax-efficient way to provide for retirement despite charges

During the bust, successive governments looked at various elements of the pensions system in both the public and private sector and saw euro signs. Levies were introduced in the private sphere, deductions were imposed on public servants and changes in the level of relief available on PRSI and then universal social charge (USC) contributions were imposed across the board.

The pension deduction levied on public servants as part of emergency financial measures introduced still averages 7 per cent and remains “integral” to meeting the overall deficit reduction target, a report published this summer by Minister for Public Expenditure and Reform Brendan Howlin found.

That is hardly surprising given it raises about €900 million a year. At least up until now. It has been amended as part of public-sector negotiations and the changes will be rolled out from January, but while the ceiling below which it can be avoided has been raised it is unlikely to be scrapped and will raise more than €500 million for the exchequer next year.

Pension levy

Public pensions are paid on a pay-as-you-go basis, which means there is no pension pot and the pensions are paid out of general taxation. When it comes to private-sector pensions it is a different story. In 2011, the Government introduced a levy on private pensions, first at a rate of 0.6 per cent and then up to 0.75 per cent. A rate of 0.15 per cent will apply in 2015.

The 0.15 per cent levy is likely to be scrapped in the budget but the Government will still be able to take comfort from the fact that it reaped €2 billion from the levy since 2011.

But the levies were not the only places pensions were targeted. People who put money into pension funds no longer receive contribution relief against PRSI or the USC and employers are no longer allowed to avail of PRSI relief.

Another change to pension tax breaks saw a cap on tax-free lump sums of €200,000 introduced with the balance to €575,000 taxed at 20 per cent. Furthermore, anyone whose final pension fund value exceeds the standard fund threshold of €2 million (previously €2.3 million) is taxed at 41 per cent.

Despite changes in terms of levies and some reductions in reliefs, a pension is still the most tax-efficient way of providing for your retirement. For a start, despite whisperings to the contrary in recent years, tax relief on pension contributions has been retained at the marginal rate of income tax – 41 per cent for higher earners – while tax-free lump sums of up to €200,000 can be taken on retirement.

“If you look back at our recent history, the most successful savings scheme was the SSIA, which offered a return of one euro for every four invested. But with the tax relief element, a pension offers two euro for every four invested,” says Brendan Barr of Standard Life. “It is by any measure a phenomenal return.”

Investment environment

Still, people look at pensions warily. “We need to make pensions more attractive to people and we need to help them understand their potential,” Barr says.

For the vast majority of people in Ireland pensions are still the best and most tax efficient method of saving for retirement, says Peter Feighan of Davy.

“Your contributions, subject to revenue limits, qualify for tax relief – so paying a hundred euro into your pension plan effectively only costs you around €60 in your pocket for those paying the higher rate of tax.

“Investments in your pension fund also grow tax free unlike personal investments, which are likely to be subject to capital gains tax, income tax or Dirt.”