Tax changes may cause workers to end contributions

PENSIONS:TAX RELIEF on pensions is to be reduced sharply under the National Recovery Plan. The Government has decided to restrict tax relief on pension scheme contributions to the standard rate of income tax (20 per cent). At present, higher rate taxpayers can avail of relief at 41 per cent.

The adjustment is significantly more severe than the proposal in the National Pensions Framework to grant relief for all contributions at 33 per cent, regardless of income, which had been accepted by the Government.

The reduction will be phased in over three years from 2012. The relief will drop to 34 per cent from 41 per cent in 2012, to 27 per cent in 2013 and to 20 per cent in 2014.

In addition, from next year, pension contributions will no longer be exempt from PRSI and the health levy.

The Government estimates that the measures will deliver savings of €155 million next year and as much as €940 million in a full year when fully implemented – €700 million from private pensions and the balance from lower reliefs in relation to the public service pension levy. It says the total gross cost of pension tax relief is currently €2.5 billion, with health levy and PRSI exemptions costing a further €250 million.

The plan also signals the earnings cap – the income level above which people cannot claim relief on pension contributions – will be lowered to €115,000 in the budget from its current level of €150,000.

The Government also gave notice of its intention to further curtail the standard fund threshold – the maximum allowable lifetime limit for tax-relieved pension funds – in the budget, though it did not clarify by how much. The limit currently stands at €5.4 million. The taxing of pension lump sums in excess of €200,000 as suggested by the National Pensions Framework will go ahead, with details to be contained in the budget.

The report accepts the abolition of PRSI and health levy relief alongside the reduction in income tax relief may reduce private sector pension savings, contrary to current Government policy. The report says the Government is “willing to engage with the industry to examine alternatives to deliver this outcome [€700 million in savings]”. However, the main thrust of pension industry policy has been to lobby for a reduction in the earnings cap rather than cuts in relief.

With the proposed €35,000 reduction in the earnings cap delivering just a fraction of €200 million in annual savings, it is difficult to see where €700 million can otherwise be found.

John Heffernan, a tax partner at Ernst Young, said the phasing out of reliefs was a retrograde step that would see people stopping pension contributions after 2014 where possible. “Why would you make a contribution which costs you a net 80 per cent only to be in a position whereby you could conceivably be exposed to tax rates of circa 50 per cent when you draw down your pension,” he said.

Irish Taxation Institute president Andrew Cullen said the changes come “at a time when 45 per cent of the population does not have an occupational pension provision, an issue which has serious implications for the long- term viability of pensions”.

Mercer partner Michael Madden said the lower reliefs would further hamper the ability of the many pension schemes that currently fail to meet the minimum funding standard to recover, as they would act as a deterrent to the necessary increase in contributions.