A pension is the single best way to save for your retirement. It is a long-term savings plan that you can use to build up a fund to give you pension payments when you retire from work. Unlike other savings plans a pension gives you tax benefits to encourage you to save but also to allow your fund grow in an efficient way. Better still is that it is not just your pension fund that attracts benefits, these extend to your income at retirement and your inheritance planning. Here’s a quick snapshot of the key tax advantages of a pension.
Advantages of a pension
1. Tax relief on contributions
It is widely known that one of the most significant benefits of contributing to a pension in Ireland is the generous tax relief on contributions. When you contribute to a pension plan, whether it's a personal pension, an occupational pension, or a PRSA (Personal Retirement Savings Account), you can deduct those contributions from your taxable income, effectively lowering your income tax bill. The amount of tax relief you receive is based on your marginal tax rate. For example, if you are in the 40% tax bracket, every €1,000 you contribute to your pension effectively costs you only €600, as you receive €400 back in tax relief.
Just be aware that the amount of contribution eligible for tax relief is capped at a percentage of your earnings, which increases with age and the maximum salary you can claim relief on is €115,000 p.a.
2. Tax-Free growth on your fund
Unlike other investments, the contribution in your pension fund grows tax-free. This means that any investment gains, whether from interest, dividends, or capital appreciation, are not subject to income tax or capital gains tax while they remain in the fund. This allows your pension pot to grow more quickly than other taxable investments.
The compounding effect of tax-free growth can significantly enhance the value of your pension over time, making it a powerful and efficient way to build retirement wealth.
3. Tax-Free lump sum on retirement
Another advantage of having saved for your retirement in a pension is that when you reach retirement age you can withdraw a portion of your pension savings as a tax-free lump sum. The amount you can withdraw tax-free depends on the type of pension plan you have and its total value, buti t can be as high as 25% of your pension fund. For occupational pensions, the tax-free lump sum is generally capped at €200,000.
4. Reduced tax on pension income
After withdrawing your tax-free lump sum, the remainder of your pension fund can be used to provide a regular income during retirement. While this income is subject to tax, it often attracts a lower rate than during your working years as your overall income is reduced. Pension income is taxed under the PAYE (Pay As You Earn) system, but many retirees find themselves in a lower tax bracket at this stage.
There are also several other income tax credits and reliefs that can be claimed such as the Age Tax Credit and the exemption limits for individuals over 65.
5. Tax efficient transfer of your funds as inheritance
Another advantage of having a pension is that it can be beneficial in terms of inheritance and succession planning. If you pass away before retiring, your pension fund can usually be transferred to your spouse or dependents with favourable tax treatment. In some cases, it may be passed on tax-free, or subject to lower inheritance tax rates than other assets. This all depends on the type of pension you have and your own personal circumstances.
For example, a spouse or civil partner may inherit your pension without any tax liability, and other beneficiaries may be able to receive the pension as a lump sum or annuity with reduced tax rates, depending on their relationship to you and the value of the pension.
6. Additional tax benefits of company schemes
If you are part of an occupational pension scheme, employer contributions offer additional tax advantages. Contributions made by your employer are not considered taxable income for you, meaning they do not increase your income tax bill. Furthermore, these contributions are also free from PRSI (Pay Related Social Insurance) and USC (Universal Social Charge), enhancing the overall value of the pension benefit. One important thing to note is that if you are a member of a Company Pension scheme and your employer is contributing then this is not included in your salary limit but if it is a Company PRSA then it is included.
Employers also benefit from tax relief on their contributions, making it mutually advantageous for both employers and employees to participate in pension schemes.
Next steps
From tax relief on contributions to tax-free lump sums and succession planning advantages, a pension is a super vehicle for building wealth and securing your financial future. Whether you are starting your pension planning or approaching retirement it’s just good sense to maximise the benefits a pension can offer. You can ensure you not only save enough for the lifestyle you deserve in retirement but do so in the most efficient manner. At Searing Point Wealth Management, we’d be delighted to help you to take control of your retirement planning and work with you to build, manage and grow the optimum pension solution for you. Just contact us to arrange a suitable appointment.
