“Were you told that any tax breaks you get with a pension get taken back when you’re retired?”
If you were, then you’ve been had because it’s a complete myth.
It’s a myth because the proponents of it don’t account for a very fundamental change that takes place when you turn 65 in Ireland.
And it’s a change that completely alters your economic status.
Changing Tax Bands
When you turn 65 in Ireland your personal tax structure changes completely.
Everyone 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.
When you turn 65 with a dependent spouse, the threshold at which you start paying income tax jumps to €36,000 a year.
In other words, you pay no income tax whatsoever i.e. 0%, on anything up to €36,000 a year. Anything you earn over €36,000 is then taxed at the marginal rate of 40%.
On the surface, this might not seem like a big deal.
But it is.
Pension Tax Advantages
The majority of people at 65 start earning considerably less than they were before and the average private pension in Ireland matures at around €107,000.
Taken together, this means that anyone with a pension of this size won’t pay any income tax at all in retirement because the lower rate threshold is not applicable to them.
So, in this case, people can get;
- Full tax relief on pension contributions at 40%.
- Tax free investment growth all the way along.
- 25% tax free lump sum on drawdown and get tax free income in retirement!
Pensions get a bad rap sometimes but the ‘you lose it all in tax anyway’ is a fallacy.
Income Tax Rates
Taking it a step further means that you could take €100,000 tax free from a €400,000 pension fund.
You could then live off the income from the remaining €300,000 income tax free for the rest of your life!
And, even when you move up the scale, the effective tax rate only increases by a small amount.
In fact the rates range from 0% on a fund valued at €400,000 up to 22.86% with the maximum fund of €2,000,000!
Even with a fund as large as €1,600,000 you would still have an effective income tax rate equal to the 20% standard rate.
Income Tax on Pension Funds: €50k to €2M
So, the belief that tax benefits get taken back in retirement isn’t true.
To illustrate, here is the effective rate of income tax payable on funds starting at €50,000 up to €2,000,000.
*Assumes 4% annuity income for a 66 year old with a dependent spouse in receipt of the state pension with no other income sources;
€50,000 – €500,000
- €50,000 fund = €12,500 lump sum + €2,125 p/m (Income tax rate 0%)
- €100,000 fund = €25,000 lump sum + €2,250 p/m (Income tax rate 0%)
- €150,000 fund = €37,500 lump sum + €2,375 p/m (Income tax rate 0%)
- €200,000 fund = €50,000 lump sum + €2,500 p/m (Income tax rate 0%)
- €250,000 fund = €62,500 lump sum + €2,625 p/m (Income tax rate 0%)
- €300,000 fund = €75,000 lump sum + €2,750 p/m (Income tax rate 0%)
- €350,000 fund = €82,500 lump sum + €2,875 p/m (Income tax rate 0%)
- €400,000 fund = €100,000 lump sum + €3,000 p/m (Income tax rate 0%)
- €450,000 fund = €112,500 lump sum + €3,125 p/m (Income tax rate 1.6%)
- €500,000 fund = €125,000 lump sum + €3,250 p/m (Income tax rate 3.08%)
€550,000 – €1,000,000
- €550,000 fund = €137,500 lump sum + €3,375 p/m (Income tax rate 4.44%)
- €600,000 fund = €150,000 lump sum + €3,500 p/m (Income tax rate 5.71%)
- €650,000 fund = €162,500 lump sum + €3,625 p/m (Income tax rate 6.90%)
- €700,000 fund = €175,000 lump sum + €3,750 p/m (Income tax rate 8.01%)
- €750,000 fund = €182,500 lump sum + €3,875 p/m (Income tax rate 9.03%)
- €800,000 fund = €200,000 lump sum + €4,000 p/m (Income tax rate 10.00%)
- €850,000 fund = €210,000 lump sum + €4,125 p/m (Income tax rate 10.91%)
- €900,000 fund = €220,000 lump sum + €4,250 p/m (Income tax rate 11.76%)
- €950,000 fund = €230,000 lump sum + €4,375 p/m (Income tax rate 12.57%)
- €1,000,000 fund = €240,000 lump sum + €4,500 p/m (Income tax rate 13.33%)
€1,000,000 – €1,500,000
- €1,050,000 fund = €250,000 lump sum + €4,625 p/m (Income tax rate 14.05%)
- €1,100,000 fund = €260,000 lump sum + €4,750 p/m (Income tax rate 14.74%)
- €1,150,000 fund = €270,000 lump sum + €4,875 p/m (Income tax rate 15.38%)
- €1,200,000 fund = €280,000 lump sum + €5,000 p/m (Income tax rate 16.00%)
- €1,250,000 fund = €290,000 lump sum + €5,125 p/m (Income tax rate 16.59%)
- €1,300,000 fund = €300,000 lump sum + €5,250 p/m (Income tax rate 17.14%)
- €1,350,000 fund = €310,000 lump sum + €5,375 p/m (Income tax rate 17.67%)
- €1,400,000 fund = €320,000 lump sum + €5,500 p/m (Income tax rate 18.18%)
- €1,450,000 fund = €330,000 lump sum + €5,625 p/m (Income tax rate 18.67%)
- €1,500,000 fund = €340,000 lump sum + €5,750 p/m (Income tax rate 19.13%)
€1,550,000 – €2,000,000
- €1,550,000 fund = €350,000 lump sum + €5,875 p/m (Income tax rate 19.57%)
- €1,600,000 fund = €360,000 lump sum + €6,000 p/m (Income tax rate 20.00%)
- €1,650,000 fund = €370,000 lump sum + €6,125 p/m (Income tax rate 20.41%)
- €1,700,000 fund = €380,000 lump sum + €6,250 p/m (Income tax rate 20.80%)
- €1,750,000 fund = €390,000 lump sum + €6,375 p/m (Income tax rate 21.18%)
- €1,800,000 fund = €400,000 lump sum + €6,500 p/m (Income tax rate 21.54%)
- €1,850,000 fund = €410,000 lump sum + €6,625 p/m (Income tax rate 21.89%)
- €1,900,000 fund = €420,000 lump sum + €6,750 p/m (Income tax rate 22.22%)
- €1,950,000 fund = €430,000 lump sum + €6,875 p/m (Income tax rate 22.55%)
- €2,000,000 fund = €440,000 lump sum + €7,000 p/m (Income tax rate 22.86%)
Don’t listen to noise just stick to the numbers.
Start your pension today.
Get in touch today by calling 01 442 3929 or emailing me at kevin@thepensionstore.ie