Pensions not only make common sense they also make tax sense

Pensions, easily the most common type of tax-efficient investment, have been the subject of a marketing drive by banks and insurance companies over recent weeks.

There are plenty of reasons to take out a pension. Not having to rely on the State for support once you hit retirement age is one of them. "Everybody needs to save for a rainy day and it's no more rainy than when you're 55 or 60 and your income drops off," says Mr Martin Phelan, head of the tax department at solicitors William Fry.

Another reason to prioritise your pension is that it makes "tax sense" to do it. Pensions, easily the most common type of tax-efficient investment, have been the subject of marketing campaigns by banks and insurance companies over recent weeks as the bangers and pumpkins season comes into full swing.

"In previous years we have seen many of the self-employed starting their pension in the run-up to the tax deadline in January," according to Mr Pat Surlis, national pensions sales manager at Bank of Ireland Life. "The message is simple. If you miss the deadline, you are missing out on reducing your tax liability as well as failing to secure your future."

A person with a tax bill of €6,000 who has a top tax rate of 42 per cent and invests €3,000 into a pension plan is making a tax saving of €1,260 (€3,000 at 42 per cent). Their pension contribution is effectively costing just €1,740.

The maximum amount a self-employed person can contribute to their pension every year is 30 per cent of net relevant earnings, but only if you are aged 50 or over or if you earn your living from certain listed occupations where early retirement is the norm, for example if you are an athlete.

People in their 40s can contribute 25 per cent of earnings, people in their 30s can put 20 per cent aside, while people under 30 have a maximum contribution rate of 15 per cent of earnings. Employees who are members of occupational pension schemes can also make tax-efficient additional voluntary contributions (AVCs) to their pensions along the same sliding scale.

A person under the age of 30 may not be able to afford to pour 15 per cent of their net earnings into a pension plan, on top of substantial costs such as mortgage repayments, motor and health insurance and household bills. But by not contributing as much as legislation will allow, that person is not only reducing the amount they will have in the pot by the time they retire, they are losing out on available tax relief.

Self-employed people without a personal pension who intend on taking one out over the next few days could be better off buying a single-premium pension rather than committing to a regular-premium pension, according to Mr John Geraghty of LA Brokers.

"The biggest fear companies have is their cash-flow problems. They see their pension as another bill, even though in their heart they know it's for their retirement. With single-premium pensions, the plan is always there, it's just a matter of writing a cheque," Mr Geraghty says.

Paying regular premiums puts people in the habit of placing money aside for their retirement, a habit that they might be more likely to break if they held a single-premium pension. But people who take out a pension and start making monthly contributions now won't benefit from the full tax relief available for 2001, Mr Geraghty says.

Self-employed people may be prompted to take out a pension by the fast-approaching tax deadline, but they should avoid turning a last-minute investment into a hasty, ill-researched decision.

It is important to choose a fund that will only gamble as much on your retirement income as you would like.

Make sure your financial adviser or sales representative takes a break from stressing how crucial it is to invest before Hallowe'en to explain the risk profile of their pension funds.

Slumps in the market this year have put a spotlight on the performance of managed pension funds, which have lost a fifth of their value so far this year.

"Any savings plan in itself carries a risk element," says Mr Phelan. "Your pension is your retirement income so you should be taking a more conservative view, not speculating wildly."

Recent changes in legislation make pensions a more attractive tax-efficient way of saving for the future, Mr Phelan notes. Pension- holders can also choose to invest in a cash-based fund until they feel comfortable to go back into equities and property.

"There's good flexibility compared to the older schemes, when you had to make your contributions before the tax deadline, but you wouldn't really know how it would be invested," explains Mr Phelan.

But another type of retirement fund - open just to proprietary company directors - leads the tax-relief field, according to Mr Paul Overy of Financial Engineering Network. Company directors can invest a much greater percentage of their pay into a pension: up to 104 per cent of their salary, compared to a maximum of 30 per cent for sole traders.

"The first piece of advice I would give to any sole trader who has the ability to be incorporated is, if the one issue was pensions, incorporate now," says Mr Overy.

If a self-employed person has a salary of €50,000, he or she can put €52,000 out of surplus-to-requirements company profits into a self-administered retirement trust (SART). As a sole trader, the maximum scope for tax planning is 30 per cent, or €15,000, and only if the person is in his or her 50s.

A SART is a Revenue-approved vehicle where a company director can generate wealth in a tax-free environment, investing the money in pensions, property or stocks and shares. Mr Overy, who runs more than 220 SARTs for clients, says they make other tax-deductible investments seem rubbish in comparison.