Reducing Your Tax Bill With Pension Contributions

by | Mar 22, 2022 | Pensions | 0 comments

Thinking of reducing your tax bill? Well, maybe it’s time to consider some smart pension planning!

Pension planning is something many of us don’t start thinking about until we get older. In the heyday of our twenties and thirties, we have so much going on that retirement is usually the last thing on our minds. There’s rent to be paid, holidays to plan for, and nights out to be had.

Then comes the excitement of putting down roots, applying for mortgages, and perhaps starting a family. Even then, retirement can still seem like a vague, distant notion.

It may seem far away now, but ask anyone in their seventies and they’ll tell you that the last few decades went by in the blink of an eye. With people living longer and leading more active lives in retirement, it makes sense to think about where your income will come from when you’re no longer working.

Not only is it smart to plan ahead and take control of your future, but there are also some important tax implications to consider. There are many benefits to starting the pension planning process early, especially because when it comes to tax, pensions are treated favourably in comparison with other forms of savings.

In this article, we’ll discuss the relationship between pension contributions and your tax bill. We’ll also outline the benefits of planning your pension sooner rather than later and examine the long-term benefits of reducing your tax bill with pension contributions.

 

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How pension contributions affect your tax bill

You can get income tax relief at marginal rates of up to 40% on your contributions to an approved pension plan, whereas the standard income tax rate for most other deductions is 20%.

You are generally not taxable on your employer’s contributions, which means that this is effectively tax-free pay.

You can get income tax relief on your contributions to the following types of pension plans:

  • Occupational pension schemes
  • Personal Retirement Savings Accounts (PRSAs)
  • Retirement Annuity Contracts (RACs)
  • Qualifying overseas plans

AVCs (Additional Voluntary Contributions) are also included, but there is no relief in respect of USC (Universal Social Charge) or PRSI (Pay Related Social Insurance) for employee pension contributions.

 

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Tax relief limits

Pensions are an extremely tax-efficient form of savings due to the tax relief you can get on your contributions and investment build-up.

Tax relief is generally subject to two main limits, which are:

  1. The age-related earnings percentage limit
  2. The total earnings limit

The age-related percentage limits are as follows:

  • Under 30: 15%
  • 30-39: 20%
  • 40-49: 25%
  • 50-54: 30%
  • 55-59: 35%
  • 60 or over: 40%

The amount of income tax relief you can get depends primarily on your age, and it is based on your marginal (highest) income tax rate.

Here’s an example of how this works: Jane is aged 37 and earns €35,000 a year working for an accountancy firm in the midlands. Based on her age and earnings, she can get tax relief on pension contributions up to €7,000.

Regardless of your age, the total earnings limit is currently €115,000. In other words, that is the maximum amount of earnings taken into account for calculating your tax relief in any given year.

If you are self-employed, paying tax at 40%, and you make a €10,000 pension contribution, then you will reduce your tax bill by €4,000.

If you are a sportsperson or a professional who will retire earlier than normal, you can get marginal tax relief on 30% of your net earnings, regardless of your age.

 

How are lump sums taxed?

Investment returns earned by pension schemes are exempt from capital gains and dividend income tax.

What’s more, you can take a tax-free lump sum out of your pension when you retire. Different rules and limits apply depending on the type of pension arrangement you have, but the maximum amount that is available tax-free is €200,000.

Lump sums of between €200,001 and €500,000 will be taxed at 20%. Anything over this amount will be taxed at your marginal rate and is subject to USC.

 

Reducing your tax bill with increased pension contributions

Regardless of the type of pension scheme you have, you should review your pension position regularly. If you can afford to pay more into your pension, then this will improve your benefits and reduce your overall tax bill.

AVCs are Additional Voluntary Contributions (to a company pension scheme) that are over and above the amount an employee is required to contribute under the scheme rules.

Most schemes are defined as contribution pension schemes, which in effect means that the more you put in, the bigger your pension pot could be at retirement.

 

Advice for reducing your tax bill with pension contributions

The decisions you make throughout your career and at the time of retirement are so important when it comes to financial security, not just for you but for your dependants too.

For expert advice on retirement, savings, and pension planning, contact Symmetry Financial today.

No matter what stage you’re at, we can help you plan for your future.

If you’d like a free, no-obligation consultation for your mortgage, pension or financial needs, get in touch here, call us on 01 6831673 or email us directly on info@symmetryfinancial.ie.