3rd August 2020
What is the Standard Fund Threshold Ireland? This week, in what is a short 4 day work week, we share a short 4 minute read that will give you most of what you might need to know about the Standard Fund Threshold, for now! You’ll learn the history, the current threshold, the REAL threshold, and a little-known nugget that can help you squeeze the max value and tax efficiency out of your pension pot. I hope it helps.
The History of the Standard Fund Threshold in Ireland
It’s a threshold, a pension pot valuation above which it is possible to go. However it doesn’t make a whole pile of financial sense to fund your pension pot above the threshold. That is unless your circumstances allow us apply some smart tax efficient retirement planning – more on that another day.
It is a lifetime ceiling if you will, on the total value of pension
benefits that you draw (crystallise) in your lifetime from tax relieved pensions, where they are paid or become payable to you after December 2005.
When Revenue introduced the Standard Fund Threshold 15 short years ago, it was set at €5m. Today, it stands at €2m. In a nut shell, the government have more than halved the amount an individual can effectively accumulate in their pension pots. Pensions are still a hugely valuable method of building reserves tax efficiently, but at far lower levels than one used be able to – the net continues to close!
The Standard Fund Threshold applies to us all, whether we are self employed, directors, PAYE or other. Interestingly, the threshold was reduced last in 2014, from €2.3m to €2m. As a result, there are a small number of cases where individual had the ability to apply to Revenue for a higher threshold of €2.3m. In such circumstances it was referred to as a Personal Fund Threshold, and was dependant on their fund pension fund values on 1st January 2014 or previous.
While for many, €2m is a stretch of the imagination, there are significant numbers of people who are or will be at those levels, often due to prudent and sustained savings over many years. Not to mention the positive impact of the constant upward curve enjoyed by long term and patient equity investors!
In addition, those who were or are members of Defined Benefit pension schemes for many years can find themselves with equivalent values of well above €2m. The impact of reducing the threshold from €5m to €2m brought many individuals into the net – they didn’t do it for the fun of it!
Tony Gilhawley (our own consulting pension actuary) and Roma Burke wrote the paper ‘Private Pension Tax Relief‘ and is an interesting read to see the extend and impact of the taxation arrangements on pension structures in Ireland.
How would I reach the Standard Fund Threshold in Ireland?
The reality is that the Standard Fund Threshold does force many business owners and high income earners to stop contributing to pension early, in order to avoid the punitive tax of exceeding it. Of course, if it is investment growth or increases on deferred defined benefit schemes that push you over the limit, the pain is less apparent.
Let’s look at a quick example – you have €500,000 in pension benefits today. You are contributing €60,000 per year to pension scheme per year, and intend doing so for another 11 years. If your pension grew at an average of 6% for that period, you would finish with a pot of €1.9m. If however, your fund grew at an average 8%, your final pot value would be €2.2m – you have exceeded the Standard Fund Threshold by €200k. If you achieved 8% average, AND contributed for 13 instead of 11 years you’d exceed the threshold by €700,0000!
Can I exceed the Standard Fund Threshold in Ireland?
Clearly, you can exceed the threshold. Many people have multiple pension schemes from the same or different employments. The threshold is a total figure, that will be clocking-up as you draw or become entitled to draw on your various pension pots. A ‘Benefit Crystallisation Event’ is the technical term given to an event which signals you receiving or being entitled to receive pension benefits. Examples of when this will occur:
Tracking and monitoring your threshold and how much of it you have used at a point in time is usually relatively easy to do – it’s important it is done correctly, and your existing benefits are factored and aligned accordingly.
What Happens If I exceed the Standard Fund Threshold?
Many pension holders have already exceeded the threshold, or are on their way to exceeding the threshold. It is a costly mistake, and one should really get professional help if they think they are going to do likewise.
When you do exceed it, this is the deal. Any excess you take above the Standard Fund Threshold is subject to a tax called a ‘chargeable excess tax’. You will be forced to pay this tax at the higher rate of income tax and is deducted from your pension pot before you start taking taxable retirement income from the scheme.
If you look at this, you pay 40% tax on the excess, and then tax (PRSI & USC depending on age) on the income that you draw. This results in punitive taxation on any balance above the threshold. Again, if you have already exceeded the threshold and are still contributing money to pensions, it makes zero sense to do so, in fact it’s costing you a fortune. Taking planful action, such as crystalising it before it crosses the threshold, and various other planning opportunities based on one’s circumstances could be worth a small fortune to you.
Can I Have a Pension Pot of €2.15m?
As promised, we share a little known nugget to help you squeeze the most from your pensions if you are approaching the threshold number of €2m with your pension benefits.
With final pension benefits of €2m, the maximum tax efficient lump sum you can access is €200,000 tax free lump sum, plus an additional €300,000 at 20% rate of tax. You achieve €500k in your pocket, and in that instance have paid Standard Rate Income tax of €60k only.
One nice little nugget to be aware of. You can use that €60k tax payment to offset some of your ‘chargeable excess tax’. Simply put, if you reach a Standard Fund Threshold of €2.15m, the €60k you would have paid on the €150,000 excess above €2m, can be offset with the €60,000 you paid on the initial €500,000 lump sums. In such cases, the Standard Fund Threshold is really €2.15m before an chargeable excess tax is payable on your pension benefits.
You may say that it is a good problem to have. However, like all such scenarios, if a smart strategy is applied it can make the difference between you being bloody delighted with how it worked out, or being bitter for years to come – it really is a case of making sure you get it right. Don’t leave it until it’s a pressing issue before making a plan to come out on the right side of it! This is how we help valued clients, being an independent and expert guide.
Thanks for reading – find out more about who we help below!
Paddy Delaney QFA RPA APA
Independent Financial Planner