EPPs are often used by senior employees in preference to a PRSA or a personal pension because of their scope for higher contributions and their potentially broader scope for taking tax free cash at retirement.
Despite the name, Executive Pension Plans have a different legislative status to personal pensions. EPPs are best thought of as occupational pension schemes for a single person, or for a small group of individuals within a larger pensionable workforce.
Eligibility for Executive Pensions
Technically, because executive pensions are a type of occupational arrangement, an employer is needed if an EPP is to be set up. In practice, a sole trader or professional can become eligible for an EPP by simply incorporating their activities: for example Sean Smith the carpenter becomes Sean Smith Carpentry Limited. The employer must make a meaningful contribution to the costs of the EPP, defined as 10% of total contributions, not including Additional Voluntary Contributions.
An EPP is set up under Trust and trustees must be appointed. In the future, due to new trustee training requirements, it is likely that professional trustees will assume this role on behalf of many one-man EPPs.
Contributing to an executive pension
Your contributions to an EPP are limited by your age and income level. Contributions are eligible for relief from income tax, PRSI and the health levy. This relief is normally claimed back from the Revenue in your annual tax return.
Even if you are at the allowable limit of personal contributions, your employer is likely to be able to contribute more. The rules governing total contributions to executive pension plans are complex. We recommend that you seek advice from Mercer if you want to maximise the total of your and your employer’s contributions to an EPP.
For employee contributions, there may be advantages to structuring all or most of these contributions as Additional Voluntary Contributions rather than as formal employee contributions. There is however no absolute requirement that the employee contribute anything at all.
Benefits at retirement
At Retirement you will be entitled to:
- A lump sum, based either (i) on your final salary in the relevant employment and your years of service or (ii) 25% of the value of your accumulated fund. The first method will apply if you are taking the balance of your benefits as an annuity; the second will apply if you intend to use the balance of your benefits to purchase an Approved Retirement Fund or Approved Minimum Retirement Fund. In either case, any lump sum entitlement you may have up to €200,000 will be tax free.
- A choice between an annuity, an Approved Retirement Fund or an Approved Minimum Retirement Fund for the balance
- In certain circumstances the balance after your lump sum entitlement can be taken as taxable cash
Determinants of level of benefits at retirement
The following factors will influence the level of benefits you may receive from your executive pension at retirement:
- Your level of contributions
- Your employer’s level of contributions
- The investment performance of your chosen fund or funds
- The age at which you take your benefits
- The level of annuity rates when you take your benefits
Investing your executive pension
There are a variety of funds available within executive pension contracts, including high risk, medium risk and low risk options.
Generally speaking, the higher risk a fund, the more growth can be expected from it over the long term. However high risk funds are also volatile, and will experience many ups and downs over the course of investment. Low risk funds will be much less volatile, but may deliver much lower long term growth.
It is usually considered sensible to invest on a medium or high risk basis when you are a long way from retirement. After all, if markets fall in value, it means that your new contributions will buy in at a cheaper rate. Thus a fall in value can actually be good news when retirement is a long way off.
However when you are closer to retirement it can be sensible to reduce risk. You may wish to consider investing in a “lifestyle fund” which will automatically reduce risk as your indicated retirement age approaches.
Investment return expectations
If you invest in a low risk cash fund, returns are likely to be no higher than prevailing interest rates. If you invest in a high risk equity fund, it may be reasonable to expect returns of 4-6% ahead of inflation. In other words if inflation averages 2% per annum, then returns of 5-7% can reasonably be expected from a high risk equity fund
However higher risk funds will experience years of much better and much worse returns than this broad average would suggest.
You may want to find out more about the principles behind saving and investing. These principles are, in general, similar within a pension fund as outside of one.
Annuity rates and their relevance
An annuity is an income for life, provided by life and pensions companies. Annuity rates are the rates at which these companies will sell you an annuity.
At retirement, if you use your pension to buy an annuity, the level of annuity that you receive will be determined by the following 3 factors:
- The size of the pension fund that you have accumulated
- The annuity rates at the time
- Your age when you buy the annuity
Age at which benefits can be taken
Normally, you can take your retirement benefits from an executive pension any time after the age of 60. You may be able to take your benefits after the age of 50 with your employer’s consent. In cases of severe ill health you may be able to take your benefits earlier.
Death before retirement
In the event of death before retirement, 4 times your annual remuneration at the date of death can be paid to your dependents, together with a refund of any personal contributions to the plan. The balance must generally be used to purchase an income for life for your spouse or any one or all of your dependants.
Is my Executive Pension taxed?
In the past, not only have contributions to Executive Pensions benefited from tax relief, but the fund itself has been allowed to grow free of tax. However a pension levy has applied at differing levels since 2011 and it is projected to continue until at least 2015. The levy as announced by government has been 0.6% in 2011, 2012 and 2013, 0.75% in 2014 and 0.15% in 2015. It is unclear whether a levy will continue to apply after 2015 or not.
Mercer can help with Executive Pension Plans
Mercer is Ireland’s largest administrator of occupational schemes. We remain independent with no ties to any particular pension provider.
We are well positioned to help you to choose an executive pension that is right for you, or, if appropriate, to advise you on alternative options such as a PRSA or a personal pension.
Contact us, if you want advice on whether an EPP is the right option for you, which EPP to choose or to set up a meeting with one of our consultants. We can also give you a second opinion on your existing pension arrangements. Call Mercer today to arrange a meeting.