A Contractor’s Guide to Pensions
Webinar Recording + Transcript
This webinar formed part of Berkley’s series, “A Contractor’s Guide to Personal Finance.” This two-part series aims to address common questions that contractors have about personal finance matters. In episode two, we focused on the topic of pensions. In this episode, we are joined by John Forsythe – a Qualified Financial Advisor and a Retirement Planning Advisor based in Cork.
Webinar Recording
Webinar Transcript
What Is A Pension?
Put simply, a pension is a flexible, medium to long term savings plan which is set up in a very tax-efficient manner. A pension aims to help people provide funds to replace their earned income when they retire. While there are plenty of ways of saving for retirement, pension plans are particularly attractive because they’re flexible, portable and tax-efficient.
What is the Pensions Landscape Like in Ireland?
Since 1991, Ireland’s pension landscape has changed significantly. One major factor is that there’s a pensions time-bomb coming down the tracks. Ireland has a rapidly ageing population. Currently, 23% of the population are over 65 and are receiving some form of pension. By 2050, that figure is due to increase to 47%. So if that isn’t addressed, we’ll run out of money as a country as we won’t be able to provide the state pension and some unpalatable decisions will need to be made.
One of the ways that the government are addressing this “time bomb” is by encouraging more and more people to fund their own retirement plans. In doing so, they’ll be introducing incentives to bump up the existing incentives that are already quite generous. Contractors, and self-employed people in general, should keep a close eye on this space.
What Are Some Alternatives to Pensions?
There are other ways of accruing funds to replace your income when you retire but they all come with “health warnings”.
I often hear from people that their business will be their pension. But, if anything, the last year has shown us that this is never a safe bet.
Other people choose to invest outside of a pension structure. They’ll put together a portfolio of investments which they will take care of themselves. However, the catch is that investment growth is subject to an exit tax of 41%. So you’re taking income that you’ve already paid tax on, investing it, and then you’re paying tax on the investment growth.
You can leave money on deposit and let that build up over time. Current interest rates are practically 0%. If you do get some bit of interest, then you’re going to be hit with 33% DIRT tax.
Others choose to buy property, rent it out, and then sell it. However, you’ll pay tax on your rental income and you’ll also pay Capital Gains Tax when you decide to dispose of the property
What Benefits are Associated with Pensions?
When it comes to pensions, tax is the biggest imperative. Contractors will know that if you’re earning money, you will need to set aside a part of that for tax. A pension plan is one of the very few ways you can reduce the amount of tax that you pay.
By putting money into a pension plan, your growth within the pension plan is completely tax-free. In other words, there’s no DIRT, income tax, CGT, or exit tax.
Also, any money that you put into the pension is tax-deductable at your marginal rate (your highest rate of tax). If a contractor is paying 40% tax, then for every €100 that they put into a pension plan they will receive €40 tax relief if it’s a personal pension or 52% if it’s a company pension.
Plus, the funds will grow completely tax-free so that’s another great incentive. So you’ve more of your money working for you for more of the time. There’s no other structure out there that will give you that level of return.
When you decide to draw your pension, you can qualify for what’s called a tax-free lump sum. If it’s a personal pension, you’re entitled to take up to 25% of the fund and you can withdraw the remaining balance in a very tax-efficient manner using various credits. If it’s a company pension – you can either take 25% of it as a tax-free lump sum or you can take 1.5 times your final salary as a lump sum.
Other than that, you have a residual income. As your tax situation will change post-retirement, you will be able to take out more money tax-free. For example, a married couple can take out €36K every year completely tax-free on top of the state pension.
When is The Best Time to Start a Pension?
The one thing I would say is – don’t kick it down the road. The best thing to do is to start now. While the media often report that the biggest cost associated with pensions are fees and commissions. In reality, the biggest cost of starting a pension is delay. In other words, the longer you delay, the more expensive it will be to get anything worthwhile out of it in the end. So bite the bullet, start small and keep it going as long as you can. You’re not handcuffed to it. If you need to change it, you can.
The main thing to remember is that when you’re self-employed, nobody else is going to take care of your pension plan. It’s down to you solely. Unless you’re content to rely on the state pension, but I don’t think a lot of people are in that space.
Are Contractors Eligible for the State Pension?
Yes.
To find out what level of state pension you are entitled to, you will need to look at your PRSI Contributions. If you are unsure of where you stand with Welfare Contributions, visit MyWelfare.ie. Here, you can download all of your PRSI Contributions from day one up to now. You’ll be able to work out how many credited PRSI Contributions you currently have and how many you’re likely to have going forward and that will determine the level of income that you have from the State Pension.
If you worked in the UK for a time, you would likely have paid the equivalent of PRSI in National Insurance. There are credits allowed for that when you transfer back over to Ireland. The Irish and British systems interact with each other very well.
The old-age pension in Ireland is currently €12,956 a year for a single person and slightly less than €20K for a couple. It was never designed to provide people with the type of lifestyle that they might’ve been used to, rather the aim is to keep people out of a poverty trap. For people to enjoy some quality of life from the age of 65 on, it will be necessary to supplement their income.
You can have any number of pensions. There are revenue guidelines and limits about maximum benefits that you can draw from it. But they’re very generous and most people won’t reach them. So you can have any number of pensions.
So I’m going to present some scenarios to you.
Firstly, we have Gabriel. He is a 28-year-old Web Application Tester working on a year-long contract with a multinational tech company. He intends to keep contracting long-term as the pay is better and he enjoys the variety. He has never had a pension and wants to start one asap but he is concerned about balancing contributions with high rent.
If Gabriel is making decent money, then he will also be paying tax. He should have a pension because it’s one of the few ways he can reduce his tax bill. He’s going to be writing a cheque to the revenue commissioners, why not write a smaller cheque and send it off to the revenue commissioners and pay something back to himself?
For someone like Gabriel who is at the start of his career, something like a PRSA (Personal Retirement Savings Account) will give him a great deal of flexibility. He can stop, start, and vary the contributions to suit himself.
If he’s paying 40% tax, I would suggest he contributes €200 a month on which he’ll get €80 a month in tax relief. So the actual cost to him is only €120 a month.
Another big advantage is that Gabriel can take a lump sum every November to reduce his tax bill. This is particularly beneficial in the first few years. Let’s say in November he’s given a certain amount of tax that he needs to pay. He can put a pension in place and backdate the tax relief on that to reduce last year’s tax bill (the one that he’s settling this year). However, that has a knock-on effect on his preliminary tax for the year after because this is based on his previous year’s tax bill. So by reducing last year’s tax bill, he’s also reducing next year’s preliminary tax bill. So you’re getting a double-whammy when you’re starting out. And then that rolls along and you get your 40% tax relief every year.
Again with a young guy, you need to factor in that he’s worried about rent, saving to get a deposit on a home, getting a car, socialising… Fortunately, pension plans are flexible and he won’t be handcuffed to a premium. If his circumstances change, he can suspend the premium and return to it later on without any penalties.
It’s portable. This means that if he decides to work for a company again he can transfer the PRSA into whatever scheme his employers have.
Anna is a highly-experienced QA Manager working for a biopharma company on an 18-month contract. She worked in the UK for 8 years and for 3 of those years she contributed to a company pension plan with an employer. At 37, she’s put off starting a pension long enough and has decided that now’s the time to get it going again. How should she kick off the process and how much should she put in?
Now in Anna’s situation, she can actually transfer her UK pension back to Ireland. There is a bilateral agreement between the UK and Ireland which makes it relatively straightforward to bring back a pension from the UK and to transfer it to an Irish company over here. If she is continuing to work as a contractor then she has two choices:
- If she wants to work under an umbrella company or as a sole trader, she can set up a personal pension.
- If she sets up her own Limited Company. she can create a company pension and then transfer her UK pension into that.
The other thing then of course is just to start again with a PRSA. Anna can start putting money aside now so that there’s no break in her contribution level. If she wants to set up a company 2-3 years down the road, she should just bite the bullet and start the PRSA and throw some money into that to get it going again. She can transfer the pension from the UK and that will give her a good head start.
Anyone who has worked overseas should be able to bring their pension back to Ireland. You just need to be aware that there are bilateral agreements between a number of different countries all over the world. For example, there are agreements with all the big ones like the USA, Canada, New Zealand, Australia, While the process isn’t straightforward, it’s not overly complicated either because the systems seem to work well with each other.
With the UK, the whole area of transferring pensions will be tested with Brexit. However, this was one of the first areas that they ironed out because there are a lot of people living in Ireland who are drawing UK pensions and vice versa. So there is a special relationship between the two. So far, what we have been hearing from the Revenue Commissioners and from other interested parties is that it is working quite well and that Brexit hasn’t really affected it to that extent.
Mick is a 42-year old PMO Manager in a permanent job with a FinTech company. Up until now, he’s worked in permanent roles throughout his career however he’s thinking about making the switch to contracting for greater flexibility and more career opportunities. However, he’s worried about what will happen to his company pension if he makes the move. He has a young family and needs to factor that into his decision as well.
The first thing Mick should do is contact his employers and establish who are the trustees in the existing pension plan. He can then request information about his current plan from the trustees.
He’ll need to find out what kind of plan is it. If it’s a company pension plan it could be a Defined Benefit Plan, a Defined Contribution Plan or a hybrid of the two. This last option is particularly popular with a lot of the larger MNCs to help reduce costs.
He then needs to find out what his options are if he decides to leave the company. One option is that he will be offered the transfer value, so he needs to decide if he will take the transfer value and reinvest the money himself. Otherwise, he may be offered a Reserved Benefit. This is a pension that will be set aside from him to draw off when he reaches the normal retirement age of the current scheme (usually 65). Now that income is increased every year in line with inflation so he will get the pro-rata benefit at age 65. If the circumstances suited him, Mick can transfer the value into a Personal Retirement Bond and take control of the pension himself. With a Personal Retirement Bond, one of the biggest advantages is that at age 50 he will have access to that money. So if he wanted to, he could use the money to clear off some loans or pay off his mortgage, fund his children’s education, to leverage up his business. But he’ll have control of that money.
Mick should also look at starting another pension for his income as a contractor. He has two horses running in the race – he can have control over both of them at that stage.
Another important factor for Mick is that he has a young family. He should research what ancillary benefits are included in his current pension plan. If it’s a decent plan, then it’s highly likely that it will include Debt in Service benefits. Normally with these, you can be paid up to four times your gross annual income as a once-off payment on a debt. Plus whatever the value of your pension fund is. That’s fairly substantial and so to walk away from that without investigating alternatives would be reckless.
Another consideration is that he may also have income protection or sick pay in place. The good news is that you can transfer your pension fund or you can leave it there and have it managed for you. You can also put life insurance and income protection in place and claim tax relief. When they’re done under a pension, both of these are tax-deductible at your marginal rate. So you’re getting 40% tax relief on your life insurance and on your income protection.
Income protection insures your income if you’re unable to work due to illness, accident or disability for a prolonged period of time. On top of this, you can also insure your pension contributions. So whilst you’re recuperating you have an income coming in and your pension is funded. Again, it’s all tax-deductible and would make sense for someone in that situation.
What Is The Difference Between A Company Pension And A Personal Pension?
A company pension is when the company covers the cost of the premium. Whereas with a personal pension, you cover this cost yourself.
Personal pensions are a good fit for people who are self-employed be it as a sole trader or within a partnership. With a personal pension, you make personal contributions into it and you get tax relief.
With company pensions, because the company is paying for the premium on your behalf, there’s a lot more scope to pay larger contributions and to enjoy more tax relief.
Can my Spouse Draw from My Pension if I Pass Away?
That depends.
If you are contributing to a pension and haven’t drawn from it yet, then the benefit will pass directly to your spouse and your estate if you die.
When it comes to post-retirement, you will have to decide on what kind of pension you draw off. One option is an annuity contract which is a guaranteed income for life. If you go down that route, you will have to decide what kind of annuity you want to buy. You can buy a “single-life annuity” which is paid to you and you only or you can include a spouse’s pension in it. The spouse’s pension would normally be 50% of what your own pension is. But that would have to be included when the individual comes to retirement and says “I want to draw my pension now. I want to buy an annuity to provide an income for life. But I also want to provide a spouse’s pension so that if I die, my partner will continue to receive an income.”
Another route is to put the money into an Approved Retirement Fund. If you die the entire value of that fund passes tax-free to your spouse.
If you want to create a company pension through your limited company, does this need to be done through a pension company or is there an online option?
I’m not overly familiar with any online platforms for this.
Company pensions have to be written in trust. So you would normally set up a self-administered pension. Now those were the flavour of the month for quite a long time, but there’s European legislation coming down the tracks that is going to make this option very expensive.
If you go to an insurance company, they will take care of the trusteeship. All the insurance companies nowadays have set up independent trustee companies to act as trustees for the pension fund. Certainly, with a company pension plan, you’re better going off this tried and tested route.
Meet Our Speaker
John Forsythe is a Financial Broker based in Carrigaline. John is a Qualified Financial Advisor and a Retirement Planning Advisor. John has worked as a financial advisor since 1991. In 2009 John established his own firm Forsythe Financial Planning. John advises on a wide range of financial services including investments, income protection, and financial protection for businesses and individuals. John has specialised in both pension and retirement planning and works primarily in this area with professionals and business owners.
