Money Talks: Start a pension now

I am 45 and have started to look at starting a private pension but my understanding is that whilst tax relief is available on the contributions, the proceeds of the final pension are also fully taxable so unless I am missing something major here, what is the whole point in investing?

Pension Planning is an integral part of your financial journey, and it is so important that you fully understand not only how the tax works, but you also need to consider other important particulars including the relevant costs, the funds available, accessibility, etc. I completely understand your confusion here and I will do my best to clarify as clearly as possible how pensions are taxed in Ireland and how much tax you can expect to pay when you draw down the funds at your chosen retirement age.

Firstly, income tax is payable on all relevant income in retirement regardless of whether the source is private pension income, state pension, rental income, part-time paid employment, etc. However, some exceptions apply and how much tax if any is paid on this income will basically depend on how much you earn as is the case now in your pre-retirement life.

Focusing purely on the pension side of things for now, let’s presume that your final pension pot is worth €800,000. So, the first 25% or €200,000 is payable to you tax-free. Please note that this tax-free entitlement is a total lifetime limit no matter how many different pension policies you have or when you draw them down. This is the maximum amount that is payable tax-free. 

If the pension lump sum was in the region of between €200,000 and the maximum of €500,000, then the income tax rate applicable on the amount over and above the tax-free threshold is 20%. Any amounts over this are subject to your marginal rate of tax, PRSI and USC.

The balance of the fund will be used to provide a retirement income and some of the options you have available to choose from would be an Annuity (Guaranteed Pension for Life), an Approved Retirement Fund, an Approved Minimum Retirement Fund, Vested PRSA withdrawals etc. 

No matter which option you go for, tax must be paid on the income and you must draw down certain minimum amounts from the age of 60, referred to as ‘imputed drawdowns’. Annuity Payments are not subject to PRSI, and you currently no longer must pay PRSI beyond the Age of 66. Your pension provider is responsible for deducting the applicable tax from each pension payment made to you.

Every Single person in Ireland under 65 pays income tax at the standard rate of 20% on everything they earn up to €35,300 a year. Anything earned above this €35,300 threshold gets taxed at the 40% marginal rate and this liability is then reduced by your tax credits. For married couples, one can earn up to €44,300 @ 20% and the other can earn up to €26,300 @ 20%. You do not have to pay any income tax on income up to €16,500 p.a. 

So basically, in retirement private pension payments will be subject to your marginal rate of tax of 20% or 40% and USC. (PRSI is currently payable to age 66 only). Furthermore married couples over the age of 65 can opt for the Lower Exemption Limit which entitles them to jointly earn up to €36,000 tax-free with any excess income taxed at 40%.

In summary, the reality is that very few pensioners are paying a higher rate of tax on their retirement income. So, like this majority, if the income tax applicable to your pension payments is 20% rate plus USC, this is much less than the likely 40% tax relief you received when you made the payments during your working life. 

And for even better news, when one carefully considers the other tax benefits that come with pension funding in terms tax-free investment growth and 25% tax-free cash at the end (Subject to the €200,000 limit), starting that pension as soon as possible is still an absolute “no brainer”.

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