Chapter 3 - Pensions

Jennifer is aged 64 and wishes to draw on her retirement annuity contract (RAC). The RAC has an accumulated value of €400,000. She has taken no previous pension benefits since 7 December 2005. Give two reasons why Jennifer should take the maximum tax free lump sum now, rather than place the entire fund into an annuity. (4 marks)

1. An immediate lump sum is obtained now, rather than an annuity which would cease on death.

2. The immediate lump sum is tax free (within the €200,0000 limit), while the annuity alternative would be liable to income tax at marginal rate.

3. Even if the individual wanted the maximum regular income from an annuity, they should draw the tax-free lump sum and purchase an annuity from it called a purchased life annuity. Only part of the annuity would be liable to income tax at marginal rate, rather than a retirement fund annuity where the full annuity is liable to income tax.

Ross is 67 and is drawing on his RAC. The plan has an accumulated value of €1.6m. He drew on a previous PRSA in 2014 which had a value of €400,000. He took a tax free lump sum of €100,000 from this plan.

i) What are Ross’ options when drawing down on his maturing RAC? (5 marks)

ii) Explain how Ross’ benefits under the maturing personal pension plan will be taxed. (5 marks)

1. What are Ross’ options when drawing down on his maturing RAC?

He can take 25% of the plan as a lump sum = €400,000 (The max tax – free will be €100,000 as he previously took €100,000 tax-free) The remaining €300,000 of the lump sum only will be taxed at 20%.

With the remainder he can invest in an ARF, buy an annuity or take as a taxable lump sum.

2. Explain how Ross’ benefits under the maturing personal pension plan will be taxed.

Lump Sum at €400,000. As he has previously taken a tax free lump sum of €100,000, he can only take another €100,000 tax free now. (as max tax free allowed in total is €200,000)

The €300,000 will be taxed at standard rate of 20% = €60,000 tax paid in total on his lump sum. (This is allowed as the next €300,000 from a pension lump sum after the tax free lump sum amount has been used is taxed at standard rate).

With the remainder;

• Annuity is subject to PAYE and USC

• ARF is subject to income tax @ marginal rate income tax and USC on all drawdowns

• Taxable Lump Sum is subject to PAYE @ marginal rate and USC.

* ARF and Taxable Lump Sum not subject to PRSI as he is aged 67. (i.e. he’s not under 66)

Rebecca has a PRSA, with a Maturing fund of €24,000. She has no other retirement benefits and is not in receipt of any pension income. How can she take her retirement benefits? (4 marks)

She can take 25% as a tax free lump sum; €24,000 x 25% = €6,000

She then has €18,000 remaining. She can invest in an annuity, ARF or take it as a taxable lump sum.

Explain the main characteristics of:

(i) An Insured employer pension scheme

(ii) A self-administered employer pension scheme

1. An Insured employer pension scheme Insured schemes:

The scheme is set up through a life assurance company, who manages the funds and looks after all the administration of the scheme.

2. A self-administered employer pension scheme

Self-administered: The scheme is not set up through a life assurance company but is normally set up with a pensioneer trustee company who can provide the services required on such a scheme, for example, actuarial, legal, investment and administration. These schemes are called a small self-administered pension scheme (SSAPS) and generally are set up as one-man director schemes where more control and choice of investment is available.

Sue is a proprietary director and a member of an occupational pension scheme. What are her possible options at retirement with regards to her occupational pension scheme?

Outline any restrictions that may apply. (4 marks)

Sue can choose from;

• Traditional benefit option.

• ARF option.

The options cannot be ‘mixed and matched’. If Sue uses the tax-free lump sum option on the traditional route, she cannot then have an ARF and vice versa.

Jessie is a proprietary director of her employer’s defined contribution scheme. At normal retirement age her final remuneration is €120,000 pa, while the accumulated retirement fund is €600,000. She has not taken any other retirement benefits from any source since 7 December 2005. She is not currently in receipt of any pension income. She had 25 years’ service with the company.

Outline the options Jessie has in relation to taking her retirement benefits. Show your workings. (8 marks)

Traditional Option

1.5 times FR = €120,000 x1.5= €180,000 as a tax free lump sum. (As over 20 years’ service & no retained benefits).

With the remaining fund €420,000 she must buy an annuity.

ARF Option

25% of Fund €600,000 as Tax Free Lump Sum (as below €200,000) = €150,000

With remaining €450.000 she can invest in an ARF, take as a taxable lump sum or buy an annuity.

Explain the difference between a Defined Benefit and a Defined Contribution Occupation Pension Plan. (4 marks)

• Defined benefit (DB) which promises a retirement benefit related to the member’s earnings and years of service, regardless of the performance of the underlying investments.

• Defined contribution (DC) where a retirement fund is accumulated for each member through regular contributions and investment growth. No promise on the level of retirement benefit is given. It will depend on the value of the fund at retirement

Kevin is a member of his employer’s defined contribution pension scheme. At normal retirement age of 60 he will have completed 30 years of service with the company. He has no retained retirement benefits.

His final remuneration is €60,000 pa while his accumulated retirement fund is €200,000. He has not taken any other retirement benefits from any source since 7 December 2005. He has not previously invested retirement funds in an AMRF or annuity. He is not currently in receipt of any pension income.

What are Kevin’s options regarding his pension at NRA? Show your workings. (8 marks)

Traditional Option

1.5 times final remuneration €60,000 = €90,000 as tax free lump sum

With remaining fund, €110,000 he must buy an annuity

ARF Option

He can take 25% fund as Tax free lump sum =€200,000 @ 25% = €50,000

With the remaining fund of €150,000 he can invest in an ARF, take as a taxable lump sum or buy an annuity.

Ruth is an employee member of a defined contribution occupational pension scheme. At normal retirement age she will have completed 24 years’ service with the company.She has no retained retirement benefits.

Her final remuneration is €60,000 pa while her accumulated fund is €120,000. She has not taken any other retirement benefits from any source since 7 December 2005. She is not currently in receipt of any pension income.

What are Ruth’s options at NRA regarding how she can take her retirement benefits? Show your workings. (8 marks)

Traditional Option

1.5 times final remuneration of €60,000 = €90,000 as tax free lump sum

With remaining €30,000 she must buy an annuity.

ARF Option

She can take 25% of fund as lump sum = €120,000 @ 25% = €30,000

With the remaining fund of €90,000 she can invest in an ARF, take as a taxable lump sum or buy an annuity.

What individuals are eligible to take out a retirement annuity contract? (3 marks)

Individuals who have relevant earnings liable to income tax, that is, income earned from a self-employed trade or profession or income earned from a non-pensionable employment, can take out a personal pension plan.

If an individual is in pensionable employment, that is, they are members of an occupational pension scheme through their employment, and they have a secondary income that is non-pensionable, for example, farming or teaching music, they may also take out a personal pension in relation to this relevant earnings income.

How is Income Tax relief on Personal Pension Contracts, i.e. RACs and PRSAs determined for an individual? (8 marks)

• The maximum net relevant earnings that can be taken into account for the purposes of income tax relief on RAC and PRSA contributions is currently €115,000.

• The maximum percentage of net relevant earnings (NRE) that can be invested in a personal pension or PRSA contract is based on the individual’s age in that tax year. This includes any pension term assurance premiums. There is an exception for some professionals aged under 50, mainly professional sports people where they are allowed a higher limit of 30% of earnings.

• Income tax relief is always available on PRSAs for contributions up to €1,525 per annum regardless of these age limits.

• Income tax relief can be claimed on personal contributions to an AVC PRSA for an individual in an occupational pension scheme, within the limits of the occupational pension scheme benefits and the age related personal contract earnings limit (inclusive of any normal employee contributions).

What are the two options available to an individual when drawing down their retirement benefits from a buy-out bond? (4 marks)

1. Option 1

• A lump sum of the maximum approvable deferred lump sum at the date of leaving service, increased in line with CPI from the date of leaving service.

• The balance, if any, must then be used to buy an annuity.

2. Option 2

• A once-off lump sum of up to 25% of the value.

• The balance can be transferred to an approved retirement fund or used to purchase an annuity.

List four situations that would trigger a benefit crystallisation event (BCE). (6 marks)

1. The taking of a lump sum at retirement.

2. Commencement of payment of a pension or annuity.

3. Transfer of funds at retirement to an ARF, or to the individual as a taxable lump sum.

4. A transfer value payment made to an overseas pension arrangement.

5. PRSAs at age 75 trigger an automatic BCE as they become vested.

How is a Chargeable excess arising on a BCE calculated?

A chargeable excess arising on a BCE is calculated as:

Total cumulative gross value of all retirement benefits taken on a BCE since 7th December 2005 LESS the Standard Fund Threshold or the individual’s Personal Fund Threshold, if higher.

Kate retired in 2023 and drew on a personal pension plan in February 2023 valued at €1.5m, and at the same time also drew on a PRSA valued at €2.0m. She has not drawn on any pension plans previously. She has no personal fund threshold.

Assuming that she only takes €500,000 as a lump sum in total, calculate the tax liability on her chargeable excess. (10 marks)

Total Plan Values €3.5 million ( €1.5 m + € 2.0m)

Standard Fund Threshold = €2 million

Chargeable excess =€3.5m -€2m = €1.5 million

Tax on this = €1.5m @ 40% = €600,000

However, allowance is made for any standard rate tax already paid on lump sum;

Total lump sum = €500,000

Tax free portion = €200,000

Therefore, tax on remaining €300,000 from lumpsum@ 20% = €60,000

Total Tax charged on Chargeable excess = €600,000 - €60,000 = €540,000

Brendan is a proprietary director who is crystallising his defined contribution occupational scheme at age 70 in 2023. The value of the fund is €1,500,000. In June 2013, when he was aged 60 he received pension benefits from a previous Defined Benefit Scheme of €32,000 per annum. After taking the maximum tax-free lump sum his yearly pension from the Defined Benefit scheme was €25,000 per annum. Brendan does not have a Personal Fund Threshold. Calculate Brendan’s chargeable excess. (8 marks)

June 2013: DB Scheme of €32,000 p.a (inclusive of TFLS)

The factor to commute the annuity to a lumpsum at age 60 is 20:1 (as it was all accrued prior to 1st Jan 2014)

Therefore, 32,000 x 20= €640,000

2023 benefit = €1,500,000

Total benefits: €640,000 + €1,500,000 = €2,140,000

SFT= €2,000,000, so therefore chargeable excess = €2,140,000- €2,000,000

Answer = €140,000

Explain the features of:

i) an annuity with a reversion option

ii) an annuity with a guaranteed period

iii) an escalating annuity

iv) open market option

1. an annuity with a reversion option

• On death, part of the annuity is set up to go to another individual, typically a spouse and typically for 50%.

• This is often called a spouse’s pension or dependant’s pension.

• It is paid for the beneficiary’s lifetime.

• If the beneficiary of the reversion pre-deceases the annuity holder/retiree, the annuity ceases on death of the retiree.

• Additional costs apply.

ii) an annuity with a guaranteed period

• An initial period for which the annuity is guaranteed to be paid regardless of whether or not the individual dies during that period.

• The standard guarantee period is five years, but in most pension arrangements the individual can choose a period from zero years, that is, no guarantee, to a maximum of 10 years.

• The longer the guaranteed period, the more it costs, and the lower the annuity payment

iii) an escalating annuity

An escalating annuity is an annuity where the value paid out increases each year. This will cost more than a level annuity, but allows for the effect of inflation.

iv) open market option

The open market option allows that any individual can buy an annuity from any provider and cannot be forced to buy from the life company the pension was with.

Jake is drawing on his PRSA benefits and after taking his maximum tax free lump sum he is considering the value of taking the remaining fund as a taxable lump sum. Outline two advantages and two disadvantages of taking the remaining fund as a taxable lump sum rather than investing in an ARF.

Advantages of taxing taxable cash over an ARF:

• Where the fund available for transfer to an ARF is small, for example, less than €20,000, and the costs and charges of maintaining an ARF for such a small size may be high.

• Where a lower effective tax and USC rate might be suffered on the taxable lump sum taken now than might apply to annual ARF withdrawals, for example, where the consumer has unused PAYE allowances and reliefs and standard rate band in the year in which fund is to be taken, which might not be available in future years.

• Where the consumer needs funds now to pay off loans or other debts.

Disadvantages of taking taxable cash over an ARF are:

• Death: potential inheritance tax disadvantage for children.

• Investment returns: miss out on gross roll up of investment returns.

Outline four advantages and four disadvantages of investing a crystallised pension fund in an Annuity versus an ARF. (8 marks)

Annuity Advantages

• It provides a guaranteed level of income for life. The risk of ‘living too long’, that is, the ‘longevity risk’ is insured

• No investment risk, after the annuity is purchased. The only risk of non-payment is the risk of the life company defaulting.

• Wide choice of annuity types and benefit options, to suit different circumstances.

• Simple and easy to understand... consumer does not have to worry about ongoing income payments. Little ongoing advice needed.

Annuity Disadvantages:

• Loss of access to capital. Once invested in the annuity, it cannot be retrieved, except possibly on death.

• Mortality risk: if a capital protected annuity is not purchased, the individual could die before receiving back in annuity payments the sum invested in the annuity.

• Timing risk: return is linked predominantly to long term interest rates ruling on the day the annuity is purchased. No participation in equity returns.

• Lack of inflation protection, where level annuity or annuity increasing a low fixed rate is chosen.

• Lack of income flexibility, once annuity has started. Income pattern is set in stone, once annuity has been purchased. Can’t be varied.

Outline four advantages and four disadvantages of investing a crystallised pension fund in an ARF versus an Annuity. (8 marks)

ARF Advantages:

• No immediate loss of capital. Capital can be preserved for dependants; inheritance of ARF can be deferred until 2nd death of ARF holder and spouse; balance of ARF on 2nd death is paid to children, less tax at maximum rate of 33%.

• Income flexibility: income drawdown rate can be varied from 4% per annum to 100%, that is, total immediate drawdown. Rate of drawdown can be varied to suit changing circumstances, for example, drawdown could be increased in a period of ill health to pay for medical expenses.

• Opportunity to defer purchasing an annuity to a later date; ARF could be used to buy an annuity at a later more favourable date. For example, when annuity rates may be higher.

• Opportunity to stagger the purchase of annuities, and so reduce the timing risk involved in buying an annuity on day one.

• Capital and income are rolled up tax free, until withdrawal is made from ARF.

• Opportunity to participate in equity and property returns which offer prospect of protection against inflation; not confined, as conventional annuities, to fixed interest rate returns.

• Control over investment policy; there are a wide range of ARF products available, with a very wide range of investment fund options.

ARF Disadvantages

• Effectively required to withdraw at least 4% per annum from the ARF if under 71 or 5% per annum thereafter, which will run down the value of the ARF if investment return does not match this withdrawal rate.

• ARF bombout risk, arising from combination of investment risk, longevity risk andrequirement to draw down at least 4% per annum up to 70 and 5% per annum thereafter. Longevity risk is not being insured; Therefore, there is the risk of the ARF running out of money during the ARF holder’s lifetime or the ARF regular withdrawal amount falling significantly in value.

• If ARF is used to defer annuity purchase for a period: - there is the risk that annuity rates could be even lower when the annuity is purchased, due to improved life expectancy and lower interest rates. - Capital value of ARF available to purchase annuity could be lower than its initial value. Hence a lower annuity might be secured than could be secured now.

• Annual minimum drawdown reduces the benefit of gross roll up, and estate planning opportunities.

• Complicated; ongoing and regular advice is required to operate ARF. • As customers get older they may no longer be competent to make investment decisions.

Ruth has retired and has drawn down on her PRSA benefits. She has taken the maximum lump sum. Outline four key issues that Ruth should consider when deciding to invest the remainder into an annuity versus an ARF option with regard to the use of retirement funds at retirement. (8 marks)

1. The consumer’s need to take income from the retirement funds, in the immediate future and in the longer term?

How much income does the consumer need now? Has the consumer other sources of income in retirement, for example, social welfare pension and/or investment income, they can fall back on? Will the consumer continue to work for a period? Will the consumer have a need for a higher level of income in the future?

2. What other sources, if any, of wealth has the consumer?

Are the retirement funds in question the sole or main source of wealth the consumer has in retirement, or does the consumer have other significant financial assets they can call on?

Has the consumer one or more dependants or spouse/partner they wish to provide for?

The annuity offers limited ability and flexibility to provide for dependants, for example, through use of the guarantee period, capital protection and/or reversion. The ARF offers greater flexibility to preserve capital for dependants, subject to a minimum 4%/5% per annum withdrawal.

3. What is the consumer’s state of health?

If the consumer has a reduced life expectancy they may be able to secure an enhanced annuity rate. However, an ARF may be more suitable where a consumer has a significantly reduced life expectancy, as it can offer a much higher level of capital preservation for dependants than an annuity can. The ARF also offers flexibility in income withdrawals, so that higher or once-off withdrawals can be made to meet occasional medical expenses, for example.

4. What is the consumer’s attitude to and capacity for investment risk?

A guaranteed annuity fully insures the retiree against future investment risk, whereas an ARF exposes the retiree fully to future investment risk.

What is the minimum annual drawdown rate to avoid imputed distribution if total ARFs and vested PRSAs held by James, aged 66 amount to €2.2m? (2 marks)

6% as over €2m, therefore €132,000

Mark is leaving his current employment where he had a death in service benefit of 3 x times service. He has been offered a continuation option by his scheme. What is a continuation option? (2 marks)

A continuation option is where the employee who is leaving service where they had death benefits may be able to effect personal life assurance cover up to a certain limit with a specified life assurance company within, say, 30 days of leaving service, without being required to provide evidence of health.

Gareth is leaving his current employment, having been a member of his employer’s occupational pension scheme for 1.5 years. He had been contributing 5% of his salary pa and his employer had been contributing 10% of Gareth’s salary pa to the OPS.

Outline the three options Gareth may have in relation to the benefits in his scheme, assuming the scheme allows all the available options. (9 marks)

1. Preserved benefit of their contributions. In this case the employee is given a preserved or paid up retirement benefit related to the value of their contributions. They may also have an entitlement (called vested rights) to all or a portion of the employer contributions paid to the scheme.

2. Transfer value in lieu of preserved benefits, if any. The transfer would have to go to an approved scheme such as another occupational pension scheme, a PRSA or a PRB.

3. Refund of the member’s contributions (ROCs) which would result in the loss of benefit from any employer contributions and would be subject to tax at standard rate if taken as a cash payment; if moved to a PRSA then there is no tax deduction.

Noreen is a beneficiary of a pension adjustment order in relation to a pension scheme retirement benefit. What are the different options available to her regarding her designated benefit? (5 marks)

Noreen can:

• Wait until her husband retires and then receive her designated benefit. This is referred to as earmarking OR

• Direct the pension scheme trustees to convert her future designated benefit entitlement into a transfer value payment now, and then use this transfer value to provide an independent retirement benefit for herself. This is referred to as splitting, as the split takes place now and not at retirement. The beneficiary spouse can opt to use the transfer value to provide an independent benefit for herself in one of three main ways:

1. If the trustees of the scheme agree, it can be used to provide an independent retirement benefit for her within the same scheme as the member. However, in practice this rarely happens.

2. It can be paid to another occupational pension scheme of which the beneficiary is a member.

3. It can be paid to a PRSA or buy-out bond chosen by the beneficiary, in her own name. This latter option is generally the most popular, in particular the option to transfer to a PRSA.

What is meant by the following terms in relation to a pension adjustment order? (4 marks)

(i) Earmarking

(ii) Splitting

1. Earmarking

Leaving allocated % of Pension Adjustment Order in the pension scheme of the person who the Pension Adjustment Order was made against until they retire and then receiving designated benefit.

2. Splitting

Directing the pension scheme trustees to convert a future designated benefit entitlement as a result of a Pension Adjustment Order into a transfer value payment now, and then use this transfer value to provide an independent retirement benefit.

Dan has been awarded a Pension Adjustment Order over his ex-wife’s pension scheme retirement benefit. Outline three potential advantages for Dan in opting to take a transfer value from the scheme now, rather than waiting until his ex-wife retires to access his awarded share. (6 marks)

1. He can decide when to take his retirement benefits; he can take his benefits at the earliest age he could have taken his benefits.

2. He can control how his share of his retirement benefits will be invested in the future.

3. If the PAO is subject to variation (that is, subject to possible change or cancellation in the future) he secures his entitlement now by taking a transfer value. It can’t be overturned later on.

List two circumstances when the trustees of a pension scheme have the option to compulsorily pay out a transfer value to provide an independent retirement benefit for the beneficiary of a Pension Adjustment Order. (4 marks)

1. If the scheme is a defined contribution scheme

2. Where the member spouse ceases to be a member of the scheme; e.g. Leaving service

3. Where the member ceases to be a member on death.

Compare and Contrast a Standard PRSA and a Non-Standard PRSA under the following five headings:

i) Investment Choice

ii) Limit on Charges

iii) Disclosure of Commissions and Charges

iv) Access to PRSA at workplace

v) Sales and Marketing

1. Investment Choice

Standard PRSA

• Only pooled funds, that is, life company unit-linked funds and other collective investment funds like unit trusts and open-ended investment companies (OEICs).

Non-Standard PRSA

• Default investment strategy must be pooled funds, otherwise no other fund restriction.

2. Limit on Charges

Standard PRSA

Maximum 5% of contribution. • Maximum 1% per annum of fund.

Non-Standard PRSA

• No statutory restriction on level of charges. However, no monetary charge can be applied, for example, no policy fee.

3. Disclosure of Commissions and Charges

Standard PRSA

No disclosure at the point of sale. Disclosure at the point of contract issue.

Non-Standard PRSA

• Disclosure of commissions and charges required at point of sale (generic allowed) and specific (at contract issue, if not previously given at point of sale

4. Access to PRSA at workplace

Standard PRSA

• Employers who have employees not included in an occupational pension scheme must provide access to those employees not included in the scheme to at least one standard PRSA, and allow contributions to the PRSA to be paid by deduction from salary and wages.

Non-Standard PRSA

• Non-standard PRSA does not qualify for employer to provide compulsory access to a PRSA at work for those employees not included in an occupational pension scheme

5. Sales and Marketing

Standard PRSA

• A standard PRSA cannot be marketed or sold on a conditional basis, that is, that the consumer must take out some other financial product at the same time. • No document relating to the marketing or sale of a standard PRSA may ‘solicit the purchase of, or otherwise advertise any other product’.

Non-Standard PRSA

• No specific prohibitions on conditional selling or bundling with other products

Lisa has a matured PRSA with a fund of €400,000. Outline the various options open to her when accessing her pension fund. (4marks)

She can;

1. Take 25% as a Lump Sum - €100,000 (This is tax free assuming she has not already received €200k from pension lump sums previously)

2. The remainder can remain in the vested PRSA, invested in an ARF, taken as a taxable lump sum or used to buy an annuity.

Compare and Contrast a Personal Pension Plan and a PRSA under the following six headings:

i) Death

ii) Transfers In

iii) Transfers Out

iv) Provision of Regular Information

v) Who can contribute

vi) When benefits can be taken early on retirement

1. Death

Personal Pension Plan (PPP)

• Value paid to estate.

PRSA

• Same as personal pension plan.

• If 25% lump sum has already been taken, any remaining balance in the PRSA on death is taxed as an ARF.

2. Transfers In

PPP

• From another personal pension plan only.

PRSA

From:

• Occupational pension scheme, subject to member having less than 15 years scheme service, on scheme wind up or leaving service.

• Another PRSA.

• A personal pension plan.

• Pension adjustment order transfer value from any pension arrangement

3. Transfers Out

PPP

• Can be transferred to other personal pension plan or PRSA.

PRSA

• Can be transferred to other PRSAs and occupational pension schemes.

4. Provision of Regular Information

PPP

• Under Life Assurance Disclosure Regulations, policy holder must receive an annual statement of value.

PRSA

• Client must be provided with a half yearly statement of account, showing contributions paid since last statement and current value of PRSA.

• Client must be provided with a half yearly investment report on the fund or funds the consumer is invested in.

• Client must be provided with initial and ongoing annual statement of reasonable projection showing current annual value and projected retirement benefits.

5. Who can contribute

PPP

• Only the individual normally. • However, employer can contribute provided payment is treated as a benefit in kind (BIK) for income tax.

PRSA

• The individual; or,

• Employer; or,

• Individual and employer.

6. When benefits can be taken early on retirement

PPP

• Permanent incapacity.

• Certain self-employed occupations from age 50 onwards.

PRSA

• Permanent incapacity.

• Certain self-employed occupations from age 50 onwards.

• Employees on early retirement from 50 onwards.