Maximising your pension contributions is a great way to provide you with an adequate retirement income while minimising your tax bills
There are two very strong reasons for you to maximise your pension contributions. These are:
- Provision of an adequate retirement income
- Minimising your tax bills
Using your pension to reduce your tax bill
Pension contributions provide a means of paying less income tax. Up to Revenue Limits, contributions to a pension qualify for relief from income tax. This effectively means that, where the higher rate of income tax is 40% and you are a higher rate taxpayer, a €100 contribution to a pension will only have a net cost to you of €60 (had you not made the contribution, the other €40 would have gone to the government as income tax).
Pensions carry another tax benefit: they grow free of tax, unlike deposits (which are generally subject to tax on interest in the form of DIRT) or investment in property or shares (where rent or dividends are liable to income tax and gains in value are subject to Capital Gains Tax).
When pension benefits are drawn down, a Retirement Lump Sum can usually be taken either completely free of tax or subject to a beneficial rate. The rest of the benefit, usually taken in the form of an ARF or an annuity, is taxable. However many people will find themselves in a lower tax bracket in retirement than when they were working and making contributions, and so will have made a net gain from tax relief.
Maximum pension contributions for individuals
Broadly speaking, the maximum amount that you can contribute to a pension in a given year is determined by your age and your income.
The Revenue applies percentage limits to an individual’s pension contributions based on age, as set out below. These percentage limits are applied to a person’s “Net Relevant Earnings”. Net Relevant Earnings are broadly identical to your income from employment or self employment. However, for the purposes of calculating maximum pension contributions, Net Relevant Earnings are limited to €115,000 per annum.
The table below illustrates the maximum pension contribution for individuals as a percentage of Net Relevant Earnings.
MAXIMUM PENSION CONTRIBUTION AS % OF NET RELEVANT EARNINGS
Up to 29 years
30 to 39 years
40 to 49 years
50 to 54 years
55 to 59 years
60 and over
EXAMPLE 1: Jim is 42 and earns €50,000 per annum from employment. His maximum individual pension contribution is 25% of €50,000 – or €12,500. Jim’s marginal rates of tax will depend on his personal circumstances, but a total marginal rate of 40% would be normal for someone on this level of income. Due to tax relief, making the €12,500 contribution to his pension will cost Jim a reduction of only €7,500 in his take home pay.
EXAMPLE 2: Mary is 60 and earns €300,000 per annum. Because Mary is wealthy retirement income is not a concern for her, but she does want to minimise her tax bill. Her maximum contribution is however limited to €46,000 i.e. 40% of the maximum net relevant earnings figure of €115,000.
Maximum pension contributions: Employers contributing to PRSAs
If your employer contributes to a PRSA on your behalf it is important to note that employer contributions count against your maximum total contributions.
EXAMPLE: Take Jim in the example above, who is 42. Suppose that both Jim and his employer are contributing to Jim’s PRSA. If Jim’s employer is contributing a figure equal to 10% of Jim’s salary to the PRSA, then Jim’s own personal contributions are limited to 17.5% of salary. This is because the maximum percentage of net relevant earnings that can be contributed at his age is 25% inclusive of the employer contribution but the 10% employer contribution can also be included in the net relevant earnings calculation i.e. Jim can contribute 25% of (salary plus employer pension contribution) less employer pension contribution.
Maximum pension contributions: Employers contributing to occupational pension schemes
Employer contributions to occupational pension schemes, as opposed to PRSAs, are subject to different limits that relate to your earnings, service and the level of fund you have built up to date. These are often higher than the individual limits.
This is particularly useful if you are a senior employee, as you can use employer contributions as a means of increasing your pension contributions beyond the normal individual limits.
EXAMPLE: Suppose Mary, in the example above, owns her own company – or is a sole trader who could incorporate her business. Although Mary is earning €300,000 per annum, the limit on Net Relevant Earnings restricts her pension contributions to €46,000 per annum. However that limit can be exceeded if the company’s earnings are used to make employer contributions to Mary’s pension. This works out nicely for Mary, as she is paying very high rates of tax on her income and the money would serve her better in a pension fund.
Limits on total contributions to occupational pension schemes
The Revenue sets limits on the total contributions of employers and employees to occupational pension schemes. For employees in occupational schemes, there are a number of rules that must be observed:
- The maximum pension that you can receive from an occupational pension scheme is roughly 2/3 of your final salary. This limit may be lower if you have under 40 years of service at retirement and will be lower if you have under 10 years of reckonable service
- The Revenue limits the annual contributions you and your employer can make to an occupational pension scheme. Calculating these limits is complicated and so, if you wish to maximise employer contributions, you should seek Mercer’s advice
- Overall, the tax treatment of any pension fund in excess of the government’s maximum limit of €2m at retirement is likely to be punitive