Introduction
Each year, many business owners with company profits will be considering how to take these profits in a tax efficient way from their company. As most people are aware, a company pension plan is one of the most tax-efficient ways of extracting profits from a business.
We often find that business owners view their company pension plan simply as a way of providing a source of income in retirement. It should, however, be considered as a tax-efficient investment vehicle incorporated into a long-term investment portfolio and strategy, along with their other assets such as their business, properties, share portfolio, savings, and other investments. As such, when choosing investments options within your pension plan, it is important to select those investments that fit with your overall investment portfolio and long-term objectives. Currently, the Revenue will allow you accumulate a pension fund to a limit of €2m in your lifetime. This is known as the Standard Fund Threshold, and it provides an important tax-efficient investment opportunity.
For SME business owners who build up value in their business over time, it can be a mistake to focus only on Retirement Relief when it comes to retirement planning, and not fully maximising the tax effectiveness of a pension plan in building long-term wealth, as part of their business exit strategy. A retirement strategy that incorporates both pension planning and Retirement Relief can provide the most tax effective exit from your company when the time comes.
What is a company pension plan?
A company pension plan is set up in trust and approved by the Revenue as a tax-exempt arrangement. With this trust structure, the assets of the pension plan are kept totally separate from the company and held for the benefit of the pension plan member. If a company director is an employee of the company and is in receipt of Schedule E income from that company, he/she is eligible to set up a company pension plan for their own benefit. Company owners and directors tend to have more control over the type of pension arrangement the company can put in place for them, which can provide them with more investment options to choose from. They would typically choose an Executive Pension plan or Small Self-Administered Pension Scheme.
Unlike investing privately, investments within your pensions plan grow tax-free and are not subject to tax on income or gains i.e. income tax, capital gains tax, exit tax or dirt, while they stay invested within the plan. Therefore, they can form an important part of a long-term investment portfolio and wealth accumulation strategy.
Tax Benefits on contributions made
Employer contributions to company pension plans are fully tax deductible for corporation tax purposes, up to certain limits. These contributions are not subject to PRSI or USC.
Employer ‘special contributions’ are single employer contributions, allowed by Revenue, that can be made by the company to the individual’s pension plan in respect of their previous years’ service with that company, and can be used to accelerate funding towards the €2 million threshold. If the special contribution into the company pension scheme is more than the ongoing regular annual contribution, the company can spread forward the relief over a number of trading years. This can have the effect of potentially reducing corporation tax payable in future years.
Member contributions to company pension plans receive income tax relief. So currently, a company director who is paying income tax at the marginal rate, can contribute a % of their salary or earnings each year to their pension plan and receive tax relief at 40%. The % they can contribute is age related and is subject to an earnings limit (currently €115,000).
Build a Tax-Free Cash Lump Sum for when you retire
When you retire, you are entitled to take a Cash Lump sum from your company pension plan. The maximum tax efficient retirement lump sum is set at 25% of the SFT (currently €500,000). The first €200,000 of this lump sum is tax- free, with the balance between €200,000 and €500,000 taxed at 20%.
Providing an income in retirement tax-efficiently
So, you have built up the maximum pension fund of €2m at retirement and taken the maximum cash lump sum, what happens the rest of your fund of €1.5m?
The balance of your fund is transferred to a tax-efficient investment fund in your own name called an Approved Retirement Fund (ARF). Like a pension plan, ARF investments are allowed to grow free of income tax and capital gains tax while invested in the ARF. Only when funds are drawn from an ARF will a tax liability arise. These drawdowns are liable to income tax, USC and PRSI (if applicable) in the same way as income tax is payable on salary. The Revenue requires that a percentage of your ARF is automatically deducted every year and paid to you. From ages 61 to 70, 4% is deducted and from age 71 this increases to 5%.
In retirement, your ARF can be used as the part of your investment portfolio that provides the income you need to support your lifestyle and needs.
Conclusion
When developing an exit strategy from your company, it is important to have a plan in place that allows you consider all the tax reliefs available to boost your long-term personal wealth. Also, success will be determined by an appropriate investment plan which incorporates all your assets and is aligned to your long-term objectives. Finally, it is important to seek good tax, legal, pension and investment advice that interact when considering any business exit strategy or retirement planning.
If you would like to find out more about how Acuvest can help you with your retirement planning, please contact Aengus Moran, Investment Advisor, on 01 634 4807 or email directly at aengusm@acuvest.ie.
Footnote:
Retirement Relief
This is a Capital Gains Tax (CGT) relief, which can be applied in certain circumstances when disposing of a business or a farming qualifying asset. For many business owners, their company shares form an important part of their overall investment portfolio. Therefore, when it comes to the time to dispose of these shares, Retirement Relief minimises the Capital Gains Tax (CGT) liability payable. If the individual is aged 55 or over, there is a €750,000 exemption for gains on disposal of a farm, business or shares in a company. This exemption reduces to €500,000 if aged 66 or over. You must have owned the assets for at least 10 years prior to the disposal. However, you don’t have to “retire” to avail of the relief.
