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Wednesday, 17th April 2024
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Pensions revolution
The Finance Act revolutionises the rules relating to self-employed pensions. The impact is primarily economic rather than tax related.
T he current Minister for Finance is one of those rare Ministers who can rightly claim to have had a major input into his own Finance Act. The fate of most Ministers is to shepherd their officials’ proposals through the Dail. No one can doubt but that the proposals in relation to pensions originate from the Minister’s own passionate interest in pension reform.

Although some of the changes proposed by the Minister do have tax consequences, and although the changes all relate to the tax rules governing approved pension contracts and schemes, their real impact is economic rather than fiscal.

Existing pension rules require that while 25 per cent of the fund may be taken out in a tax free lump sum, the balance must be employed in the purchase of an annuity. In consequence one of the most substantial investments built up by a self-employed person in their lifetime evaporates on their death, or at latest on the death of their spouse. To make matters worse, annuity rates are currently poor due to low interest rates. The change the Minister has made is to remove the requirement for the purchase of an annuity and therefore to permit the self-employed person to retain the capital which he has built up in his pension fund, as his own property, capable of being bequeathed to his family. It also leaves him free to have the capital managed in a fashion that will maximise a return.

The scheme broadly involves putting a minimum of £50,000 into an Alternative Minimum Retirement Fund. This is a managed fund whose capital cannot be touched by the pensioner until he reaches the age of 75 years. He is entitled to take the yield from the fund in the meantime. At age 75, the capital is released to him to do with as he pleases. The balance of the accumulated retirement fund (less the amount taken out as a tax free lump sum) is put into an Approved Retirement Fund. Both the capital, and the yield from the capital, is available to the retiree at any time to be used as he pleases. Whereas he pays tax on the yield from the fund personally on an ongoing basis, he does not pay tax on the capital of the fund unless he draws on it, in which case it is charged to income tax. There are complex provisions for the taxation of the capital of the fund on death.

The consequence for the “pensioner” should be that he gets a higher standard of living due to better investment of the funds in a mixed portfolio. He also retains the entire of the funds as his personal capital, to spend or bequeath as he chooses.

There will be losers. While annuity rates are poor at present due to low interest rates, it is possible that in a few months time somebody who put their capital sum into the equity market right now could have cause for regret (or perhaps not!). Higher returns rarely come without higher risk. There will also be the minority who make silly decisions with their money. It remains debatable as to whether some minimum annuity purchase, as a safety net, should not have been retained as a requirement.

The new arrangements by and large do not apply to pension schemes provided by employers for their employees. Where such a scheme is a defined benefit scheme, poor returns from annuity purchases translate directly into a higher cost to the employer for funding the pension. There is strong argument that employers should be allowed the same freedom from annuity purchase, at least to some degree, as a means of controlling costs. The same arguments apply to employees’ AVCs, and to defined contribution funds, where the employee should have the same freedom as the self-employed person.

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