IPN 2022 October

To AVC or not to AVC, that is the question

Making Additional Voluntary Contributions (AVC’s) to your existing employer-funded pension scheme is perhaps the most underutilised tax break currently available. Why is this?

Written by Kieran Moore QFA, SIA, Director,Moore Wealth Management Ltd

Moore Wealth Management has been advising the Irish Pharmacy Community for over 20 years with extensive knowledge of the sector. They can be contacted at 086-3801868, kieran@mwm.ie or www.mwm.ie

Under 30 15 %30-39 20 %40-49 25 %50-54 30 %55-59 35 %60 or over 40 %We all remember the popularity of the government SSIA savings accounts Introduced in the Finance Act 2001. This was primarily because both the message and benefits were clear. The SSIA was structured so that the Government contributed one euro for every four invested by the account holder. The maximum contribution was ¤254 per month. A great deal for all concerned, the government topped up your investment by 25% effectively giving you a return of at least 25% before any other investment returns were considered.

So how does this compare to the benefits currently offered by AVC’s?

Let’s look at a case study to see. John aged 50 owns a Pharmacy for the last 10 years and currently pays himself ¤80,000 and his spouse Mary also aged 50 has a salary of ¤30,000. The revenue commissioners at their respective ages will permit employer pensions contributions of circa 80% of both salaries. With this in mind, they currently have annualised employer contributions to two company paid pensions of ¤64,000 and ¤24,000 respectively. They also have ¤50,000 surplus cash sitting on deposit earning nothing and are looking to invest these funds for the longer term.

If john increases his salary to ¤100,000 and makes an AVC contribution of ¤30,000 (using his full 30% allowance) into the existing employer pension before the tax deadline this year

his taxable salary will reduce to ¤70,000. If Mary’s salary is increased to ¤40,000 with another AVC for her of ¤12,000 reducing her taxable salary to ¤28,000.

The following benefits will accrue to them

• The combined taxable income has decreased from ¤110,000 to ¤98,000 with an estimated saving on tax, PRSI and levies of ¤5,700

• The ¤42,000 invested in the AVC’s only cost them ¤25,200 thanks to the government tax break. In other words, the immediate return on the ¤25,200 was 67%.

So, the benefits of an AVC are almost 3 times better than the offer the government made under the terms of the very popular SSIA scheme.

But the benefits do not stop there, here is some of the other benefits that John and Mary can now enjoy.

• All investment returns on the funds invested in AVC’s will be free of tax for the duration of the contract (unlike SSIA investment returns which were taxable). This gross roll-up of returns will add significantly to the final overall pension pot.

• Because employer contributions are linked to salary and service, the increased salaries will now trigger two additional sets of increases. Annual contributions for John can increase to ¤80,000 per annum and for Mary she can increase to ¤32,000.

• Back service credits for additional employer pension contributions will also be created going back ten years, these would be approximately ¤150,000 for John and ¤90,000 for Mary. In total in year one approximately ¤272,000 of additional funds could be extracted from the company to the pensions free of all income tax. With an additional ¤32,000 every year thereafter.

• The company can claim the pension contributions against its profits and therefore reduce its corporation tax liability.

Over ten years even with no investment growth the pensions would be boosted by the following

John

AVC’s ¤300,000Lump sum employer contributions ¤150,000

Additional employer annual contribution ¤160,000

Additional pension contributions ¤610,000

Mary

AVC’s ¤120,000Lump sum employer contributions ¤90,000

Additional employer annual contribution ¤80,000

Additional pension contributions ¤290,000

So, by increasing John and Mary’s salaries and using an AVC to offset the tax on these increases we could achieve the following benefits

• Reduce income tax

• Boost their pensions

• Reduce corporation tax

There is no doubt that AVC’s should play a larger role in your financial planning, especially for those of you who have both personal and corporate cash deposits. As we have explained in a previous article the erosion of the purchasing power of funds left on deposit in the medium to longer term is dramatic. Using these funds toward increased employer contributions or introducing AVC’s would be an excellent starting point in tax efficiently growing your wealth.

AVC’s are permissible by the revenue on the following agerelated scale as a percentage of salary to a maximum allowable salary of ¤115,000

Percentage Limit

In other significant pension news

You may have heard in recent changes that there have been significant changes to the regulation of the type of pension that most of you as business owners are operating at the moment that you need to be aware of.

The Technical Piece

Institutions for Occupational Retirement Provision(IORP II) a European Directive was transposed into Irish law in April 2021. Ireland, like other EU Member States, had the option to exempt pension schemes with under 100 members from certain onerous and costly requirements but decided not to. While 100-member schemes would be significant to remove from the regulations, the fact that onemember pension arrangements like yours were not exempted came as a major shock. Ireland has a high number of these that operate under a trust system that falls under IORP II unlike other countries where there isn’t a requirement for a trust meaning the level of compliance and regulation on your schemes is already very high.

Under threat of penalty from the pensions authority for the pension holder, the trustee and the life office, all the major providers of pensions in Ireland withdrew from the market and in the process cut off the only viable pension funding option for business owners at a time when we are continually told about the looming pensions timebomb. In a nutshell, the pensions authority has put the same requirements that govern large schemes (500+ members) onto schemes with one member.

The idea of schemes for one member under a trust arrangement recognized the nature of starting and running your own business where due to cashflow you may not be in a position to fund your pension in the early years. It recognized the peaks and troughs and rewarded entrepreneurship for building a business. The structure allowed for a backdated contribution to your pension for past service where you had not been in a position to save for your future.

Take a scenario where a 50-yearold business owner with ten years of service to date on a salary of ¤75,000 had not been able to fund a pension. Under revenue maximum funding calculations the option to extract ¤580,000 from the business tax-free was

available. Under the only option now available with these changes which is a PRSA the same person could fund their pension to the amount of ¤22,500, a near 96% decrease.

PRSAs were typically not recommended for business owners for the following reasons

• Lower Allocations – that means 100% of your contribution may not reach your fund and be swallowed up in life company charges

• Higher fees

• Limited fund choices

• Benefit in Kind on employer contributions which did not apply to one member schemes

• No ability to contribute for back service as a tax-efficient means of extracting company cash.

• More limited monthly contribution levels

Industry Response

Due to the threat of fines and sanctions from the pensions authority the providers were left with no option but to stop the set up of any new schemes. Despite intensive talks and lobbying the authority have refused to change their stance and currently the market is looking at various options that satisfy IORPS II. These include potentially a retail master trust arrangement but there is no estimate on when this will be available. This is a very fluid matter and we will have further updates as they arise.

Possible changes in Pipeline for Finance Bill 2022?

• Similar tax relief structures for pension contributions to PRSAs as one member schemes – This will involve the removal of BIK on employer contributions above current limits

• Proposal to provide in scheme drawdown as opposed to ARF

• PRSA – An individual pension for life

• No new Personal Retirement Bond or Personal Pension contracts

What do you do if you already have a one-member scheme

• There is a 5-year derogation for existing schemes which means

that apart from investment restrictions on unregulated investments such as direct property which came into place in April 2021 your scheme does not change.

• What you have you hold – the rules are not retrospective but future investment decisions must adhere to the new rules.

• The governance, policy, and procedures changes, while not required until 2026 will in general be applied by trustees as best practice in advance of this date

• Trustee Annual Report optional before 2026

Opportunity

What this has shown to current pension holders is that you hold a supremely tax-efficient vehicle for accumulating retirement wealth and extracting funds from your business and are in an enviable position. As per the examples shown if you have accumulated cash in your business and want to contribute for backdated service now would be a good time to have a consultation to determine if this is an option for you.

Before you finalise your income tax return this year, seek advice on how to integrate the tax, investment and retirement planning to its greatest effect. The example earlier illustrates that if you are utilising all the tax breaks and revenue allowances for pensions permissible it can greatly enhance your ability to create wealth. Perhaps it starts with a simple AVC.