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23rd October 2023
How does taxation of ARF and your Tax work in Ireland work? The taxation of Approved Retirement Funds (ARF) and understanding your Pay-Related Social Insurance (PRSI) contributions are essential aspects of financial planning, especially for retirees.
Before we jump in to ARF and Tax, let’s put to bed the question of how much tax you pay when you reach retirement and draw State and Private pension incomes!
When you receive State Pension (Contributory) you will pay income tax on it if your total income is above certain limits. The maximum rate of State Pension (Contributory) is €265.30 per week currently.
An income tax exemption is available for certain individuals aged 65 or over. These individuals only become liable for income tax if their income is above a specified limit. For 2023, that limit is €18,000 for an individual who is single/widowed, and €36,000 for a married couple.
Retirees are eligible for various tax credits and reliefs that reduce their tax liability. For example, there is a personal tax credit of €1,775 for a single person and €3,550 for a married couple or civil partners.
There is also an age tax credit of €245 for a single person aged 65 or over and €490 for a married couple or civil partners aged 65 or over1. Additionally, there is a home carer’s tax credit of up to €1,700 for a married couple or civil partners where one spouse or civil partner works in the home and cares for a dependent person.
To calculate your income tax as a retiree in Ireland, you can use the PWC online Tax Calculator. You will need to enter your personal circumstances, income sources, and other relevant information. Depending on how you fill it, the Tax Calculator will then show you your gross income, taxable income, tax payable, net income, and allow you calculate your effective tax rate.
Oh, and a little unknown but interesting fact (no pun intended), is that if you donate an artefact to an approved body such as a museum, you can claim a tax credit of up to 80% of the value of the item!
Unfortunately, the item needs to have a value of at least €115k to qualify, but I’m sure we all have almost priceless artefacts up in our attics that we could instead put to effective tax use!?
An ARF is a post-retirement investment option that allows individuals to invest their pension fund after retirement, providing more flexibility and control over their retirement savings. Check out Blog 147 for more on ARFs.
Withdrawals from ARFs are an income and are subject to income tax. This not only includes income tax but also PRSI and USC. You do not pay PRSI after age 66 of course. And fund growth on assets retained within your ARF are not subject to DIRT or Capital Gains Tax. So any money in your ARF can grow free of tax. It is only when you draw income (distribution) from the ARF that it becomes taxable.
Upon the passing of the ARF holder, the remaining funds in the ARF may be subject to tax, depending on who is to benefit from them. There are exemptions in place.
For example, if you die with an ARF and a surviving spouse/partner, the full value of the ARF passes to your spouse or civil partner and an ARF is established in their name, without any inheritance tax implications.
However, if you pass your ARF to someone else, then tax may apply. If your ARF passes to your children aged 21 or older, the ARF is subject to a flat rate income tax of 30% instead of inheritance tax of 33%. If they are 20 or younger, they are charged at 33%. So it’s more tax favourable to pass ARF assets than any other form of asset to children over 21.
PRSI contributions are payments made by employees, employers, and self-employed individuals to fund social insurance benefits, including pensions, in Ireland.
PRSI contributions help to ensure that we benefit from various social welfare benefits, including pensions. The amount you pay depends on your income and employment status. If you’re self-employed, your PRSI contributions might be a tad different from those who are employed.
PRSI contributions impact your entitlements, particularly when it comes to the State Contributory Pension (SPC). To qualify for a full SCP, you generally need to have a certain number of PRSI contributions. Understanding this correlation between your contributions and future benefits is pivotal.
The level of PRSI contributions made during your working years can impact the amount of State Pension you receive upon retirement. Higher numbers of PRSI contributions generally result in higher pension entitlements.
If you have gaps in your PRSI contribution history, you may have the option to make voluntary contributions to enhance your pension entitlements. This is especially relevant for individuals who have taken career breaks or worked abroad in countries with no taxation agreement.
So, what happens when ARFs and PRSI contributions cross paths?
ARF withdrawals are considered income for tax purposes. In most cases, PRSI Class S rates of 4% will be deducted from ARF withdrawal. According to the Minister for Employment Affairs and Social Protection, “Any amounts withdrawn from an ARF are referred to as a distribution. A distribution is treated as income from an employment. It is subject to income tax and the fund manager must operate the PAYE system on it.”
For your ARF PRSI contributions to count towards State Pension eligibility, you must take a minimum of 5,000 euros per year from it.
Let’s say you are under 66, have packed in work, but want to keep your PRSI contributions going, to maximise your State Pension benefits. We believe you need to be generating at least €5,000 of income per year in order to benefit from PRSI Class S contributions.
If you are taking less than €5,000 from your ARF but also have some rental income for example which pushes you over the €5,000 then that will suffice too. As Revenue put it “…with reckonable income or emoluments of €5,000 or more per year, are liable for compulsory insurance at Class S.” See this piece on Gov.ie for more info!
It is possible to request a PRSI statement or to contact PRSI office directly to see if you need to make changes or voluntary contributions to bring up your eligibility for the full State Pension Contributory.
A handy thing to be aware of. If you are under 66 and want to stop working, but want to continue to make PRSI contributions, you can obviously turn on your private pension income. Although you won’t want to do that on your entire pension pot, just to make some PRSI contributions.
As we saw earlier, you might only need to generate €5,000 annual ARF income. So if you have a pension pot of €1m, and you don’t need the full €40,000 (4%), if you are under 60, you can just take the €5,000, but if you are over 60 you’ll be obliged to take the 4%. So what do you do?
We’ll if your pot is in an Occupational Scheme, or if you have a PRSA, you can ‘carve-out’ just enough into a new PRSA to generate the income you need to qualify for PRSI contributions!
For example, you are 61, you have a pot of €1m in an old Occupation Scheme or a PRSA, and you want to generate pension income of €5,000 per year for the next 5 years. In simple terms, you could establish a new PRSA, transfer somewhere in the region of €25k-€30k into it, and start drawing €5k per year from it. Simples!
Note, if you have your €1m in a PRB you can’t feasibly do this, as PRB cannot transfer to PRSA, currently. But if you have a few smaller PRBs, you may consider retiring one of them so as to generate the required income. If I’m making sense!?
Final Thoughts – Taxation of ARF and your PRSI contributions in Ireland
Understanding the ARF and Tax and the intricacies of PRSI contributions can empower us to make informed financial decisions. By staying informed about the latest taxes and seeking professional advice, individuals can optimize their retirement savings and ensure they optimise what they can. I hope this piece helps you do so.
Paddy Delaney QFA RPA APA