Business owners, in particular, should be aware of recent changes to Personal Retirement Savings Accounts (PRSAs) in the recent Finance Act 2022, which came into law on 25th December 2022. In a year that has seen the curtains largely come down on executive pension plans, which were the previous retirement savings vehicle of choice, and the launch of retail master trusts capable of catering for employers with one or more members, we have now seen significant amendments to tax rules relating to employer contributions to PRSAs that could be a game-changer for many people. These changes have made PRSAs more flexible and attractive for business owners for their retirement planning and business exit strategy and will undoubtedly increase the chance of PRSAs to become the retirement savings vehicle of choice for many who would not have considered using them previously.
Treatment of pension contributions before the changes
Benefits in Kind (BIK)
Prior to 1st January 2023, contributions paid by employers into an employee’s PRSAs were treated as a benefit-in-kind for income tax purposes in the hands of the employee. For business owners, the BIK implications made PRSAs less attractive than a company pension or Master Trust arrangement, as a pension funding option for themselves.
Limits on tax efficient contributions
As an employee, you are entitled to make personal pension contributions and receive income tax relief subject to age-related % of earnings limits and an earnings limit of €115,000.
For example, as a business owner aged 50, with PAYE earnings of €120,000 in a tax year, you can contribute 30% of your earnings to your pension, subject to the earnings limit of €115,000. In this situation, you can receive income tax relief on a contribution amount of €34,500 relating to that tax year. Any employer contributions paid into an employee’s PRSA were treated as if they were personal contributions made by the employee. If we take our example above, any employer contributions, were subject to BIK in the hands of the employee, and any combined employee and employer amounts in excess of €34,500, would not benefit from income tax relief (i.e. would effectively be made from after tax net earnings), and so would not be an attractive proposition from a tax or retirement planning perspective.
For company pensions and Master Trust arrangements, however, the maximum employer contributions that can avail of tax relief, are based on the employee’s salary and service with the company, and are not based on an employee’s personal contribution limits, providing more scope for pension funding for company owners than was previously available through PRSA’s.
So, what has changed?
A number of important Finance Act 2022 changes came into effect from 1 January 2023:
- An employer contribution to a PRSA is now exempt from employee BIK; thereby eliminating the advantage previously associate with employer contributions to a company pension scheme or master trust arrangement.
- Employer PRSA contributions are no longer included in the calculation of the maximum pension contributions for which employees can avail of income tax relief (i.e. 30% of earnings up to a max of €115,0000 referred to in the example above). This also gives the employees maximum full benefit of their tax relief limits for personal and AVC contributions.
- For a company, tax relief on all employer contributions is allowed in the chargeable period in which the contributions are paid.
It is important to highlight that the new legislation does not restrict or define the level of BIK-free employer PRSA contribution relating to an employee’s salary, company service, previous pensions or existing scheme funding. This means that employer contributions to PRSA’s are now only limited by the €2m standard fund threshold, unlike contributions to master trusts or other occupational pension schemes, which are subject to earnings and service-related limits.
Opportunities for Business Owners
- With no restriction on the level of employer PRSA contributions, business owners can extract wealth from their companies more tax efficiently, by having more control over their pension funding. For example, if your company has an exceptionally profitable year, you can make a larger employer pension contribution to your PRSA for that tax year without restrictions. This makes reaching the maximum tax efficient pension (Standard Fund Threshold) of €2m achievable for all business owners regardless of their salary and service with the company.
- If you have a spouse or family member employed in your company, they are also entitled to a maximum tax efficient pension of fund of €2m also, which is very important to note.
- With a PRSA, you can access your pension benefits from between age 50 and 60, but you do have to terminate employment with the company. However, unlike a company pension plan or Master Trust arrangement, you are not required to dispose of any shareholding or terminate links to the business if you are a company director.
- By splitting your pension benefits across multiple PRSAs you can mature these contracts in stages up to age 75, thereby allowing you to phase your retirement. This will give you more control over how you take your benefits. When retiring from a company pension plan or Master Trust arrangements you do not have this option.
The recent changes to PRSAs now need to be considered by business owners as part of their retirement and business exit planning. It has opened up more options for business owners, which should be evaluated as part of robust wealth planning. However, it is important to note that other pension options may be more suited to your needs and provide better value for money. Before making any decisions, you should seek advice from an independent advisor.
Aengus Moran is an Investment Advisor and Certified Financial Planner (CFP®) with Acuvest. He has over ten years’ experience in the financial services industry, specialising in pensions and retirement planning as well as investment planning.