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Turning Company Profits into Personal Wealth

Turning Company Profits into Personal Wealth

Executive Pension arrangements are perhaps the most tax efficient way of providing pension benefits for Company Directors, key employees, and family members employed in the business.

 

If your business is doing well and generating healthy profits, now may be the time to start extracting it from your business!

 

As a Company Director or spouse employed in the business, one of the most attractive and tax-efficient ways to extract profits from the company and turn them into personal long-term wealth is by way of transferring those profits into a company pension.

 

Where the company has excess profits which the company directors wish to transfer into a company pension, it is often more tax efficient for the employer to make an employer pension contribution to an Executive Pension. The advantage here is to avoid a personal tax liability for the member which would be the case when using other profit extraction methods such as increasing salary/bonuses or taking share dividends.

 

Conventional extraction methods will cost you more:

You may decide to take profits from your company in the more conventional ways, but these will just leave you paying more tax:

 

  1. If you take it by way of salary, you may have to pay income tax at up to 40%, USC up to 8% and PRSI up to 4%.
  2. If you take it as dividends, you would pay tax at up to 40%.
  3. If you use the money to buy a car for yourself, you pay Benefit in Kind at up to 30%.
  4. If you sell your company, you pay Capital Gains Tax at 33%.
  5. In the event of death, Capital Acquisitions Tax at up to 33% applies.

Therefore, by transferring your profits into a Company/Executive Pension you can reduce the above forms of personal tax liability.

 

 

Tax Advantages of a Company Pension Scheme

 

 

Transfer Profits into Pension | How does Max Funding work?

 

Employer contributions are not restricted by age related limits unlike member/employee contributions, but instead are related to the cost of providing retirement benefits based on “two thirds” of salary (where there is at least 10 years service at retirement). This can result in very generous contribution amounts.

 

Contributions are allowable as either Ordinary Annual Contribution or Special Contributions. The maximum allowable ordinary annual contributions to a scheme include all Employer, Employee and Additional Voluntary Contributions (AVC’s) made to the scheme in the company accounting period.

 

It is worth noting that it is possible to pay an Ordinary Annual Contribution by either regular monthly, quarterly or annual payment or by way of single premium.

 

Special Contributions are normally paid by single premium and can be used to backdate periods of salaried service which were previously not pensioned.

 

The below information is needed to calculate the maximum contribution that would benefit you on a tax efficient basis when funded by the company:

 

  1. Age
  2. Salary
  3. Gender
  4. Marital status
  5. Chosen retirement age
  6. Date that salaried service commenced & potential service
  7. Value of pension benefits relating to previous & current employments

 

 

Ordinary Annual Contribution Calculation

 

Emma is 35 and married and has a salary of €50,000. She has a Personal Pension currently valued at €100,000. She has no definitive plan for a retirement date but wants to maximize pension contributions now to the best arrangement available.

 

The Revenue limits around personal contributions mean that the maximum personal contribution she could make to a pension would be €10,000 (20% x €50,000).

 

However in Emma’s case, her salary comes from her company. As a result the company itself can make contributions to an Executive Pension arrangement on Emma’s behalf.

 

Turning Company Profits into Personal Wealth

 

As you can see the company can make a far greater contribution on Emma’s behalf than Emma could make personally under the personal age related limits. For the purpose of the calculation we have assumed Emma’s NRA to be age 60 as she has no specified retirement date and wishes to maximize contributions.

 

 

Special Contribution Calculation

 

There is also the potential for companies to make pension contributions on behalf of employees for previously unfunded service with the company. These contributions are known as Special Contributions.

 

James is 50 and has his own company from which he takes a salary of €40,000. James set up his company fifteen years ago, taking a salary for each of these years but has no previous pension funding in place. James wishes to retire at age 60.

 

Turning Company Profits into Personal Wealth

 

As you can see the company can make a far greater contribution on James’s behalf in respect of previous service than James could make personally under the age related limits. The employer could immediately make a very large Special Contribution for James from the outset.

 

Revenue limits around personal pension contributions does allow backdating where prior to the 31st October in the current year, James could make a contribution and offset against last years income tax bill but limited to age and earnings attained in the previous year. Assuming earnings were the same this would equate to 25% of €40,000 or €10,000.

 

However, Revenue also allows that contributions may be made in respect of previous service by an employer using an Executive Pension arrangement. The calculation is based on the member’s current salary and all previous years with the company where they took a salary. This can be particularly beneficial for late starters to pension funding.

 

 

Tax Relief for Employer Contributions

 

Tax relief may always be attained on Ordinary Annual Contributions in the year in which they are made.

 

Tax Relief on Special Contributions can also always be attained in the year in which the contribution is made where the Special Contribution is equal to or less than the corresponding ordinary Annual Contribution made in the same year.

 

A huge plus is that employers/the company can get corporation tax relief on allowable contributions at the rate of corporation tax which is currently 12.5%. No employer PRSI is paid on employer pension contributions to an occupational pension scheme.

 

There are further tax advantages as any contribution made is invested in a pension fund which enjoys tax-free investment growth with no DIRT, Exit Tax or Capital Gains Tax applicable to any investment return achieved by the contribution. It can also provide a Retirement Lump Sum which is tax-free up to €200,000.

 

 

How do I get started?

Contact us for Financial Advice

 

The rules governing overall contributions to Executive Pensions can be complex.

We recommend that you seek advice from one of our Financial Advisors first to make sure the company pension is set up correctly, and to maximize the overall contributions and tax-efficiency.

 

Need some assistance?

Fill out your details and enquiry below, and one of our Qualified Financial Advisors will get back to you shortly.

 

Directors Pension Scheme

 

What is a Directors Pension Scheme?

 

An Executive Pension (Directors Pension Scheme) is a product designed to allow Company Directors and senior employees to save for retirement while taking advantage of useful tax incentives, such as extracting wealth from the company in the most tax-efficient manner. Essentially, you can set up a pension for anyone employed by the company who is drawing a salary, including your spouse if they are a director.

 

The Executive Pension is setup by the limited company for the benefits of the directors and senior (key) employees under a trust, and trustees must be appointed (typically the Employer would act as the trustee). It is therefore, also safeguarded and independent of the company’s assets and its future profitability.

 

As a company director, one of the most useful and tax-efficient ways for you to extract profits from your company and turn them into personal wealth is by way of the company making contributions to the Executive Pension plan.

 

Who is Eligible?

 

With an Executive Pension both employees and employers can make contributions. Essentially, you can set up a pension for anyone employed by the company who is drawing a salary, including your spouse if they are a director.

 

I am a Sole Trader, would it benefit me to change to a Limited Company?

 

In practice, there are often cases where Sole Traders can become eligible for an Executive Pension by simply “incorporating” their activities (re-registering their company type); for example John Smith the engineer becomes John Smith Engineering Limited.

 

Before changing, the first thing you should consider is the amount of income you are earning. As a successful business owner you are now at the point where your business is growing rapidly. At this point you may find that your tax bill is starting to pile up and you are looking for solutions to reduce your tax and maximize your wealth. 

 

If your income reaches the higher level of income tax threshold it will then make sense to take advantage of the useful tax benefits available through a company pension. This would be one solution for incorporating your business (refer to below benefits).

 

How are contributions made to an Executive Pension?

 

Contributions are made into an Executive Pension plan through the company’s bank account either on a monthly basis or by way of a lump sum payment – if needed before the company year end.

 

 

Tax Advantages of a Company Pension Scheme

 

 

What are the Benefits of an Executive Pension over a Personal Pension?

 

1. Company Directors often use Executive Pensions over Personal Pensions as the tax benefits are more attractive. For example, the scope for tax-deductible contributions are higher, and there is potential for a broader scope for tax free cash at retirement.

2. You can claim the benefit of your Executive Pension from the age of 50 rather than age 60 in Personal Pensions.

3. An Executive Pension also allows you as a Director to ring-fence company money in your own name and away from the business.

 

Tax Benefit for Employers (Company Contributions)

 

One of the most attractive, tax efficient ways for company directors to extract profits from a company and turn them into personal wealth is to transfer the profits into a company pension.

 

Where an Executive Pension plan is set up, the company can make regular annual contributions to the plan on your behalf and are also not subject to a benefit-in-kind charge in your hands for income tax purposes (meaning that you will not have to pay Income tax, USC or PRSI on the company’s contributions to your plan). Here, the company is allowed to record the pension contribution as a company expense, which will help reduce the company’s Corporation Tax liability.

 

How much can a Company contribute to a Directors Pension in Ireland?

 

The employer can contribute as much as is needed to provide the maximum benefits allowed by Revenue at retirement. As a Company Director, Revenue allows you to build up a pension fund which will provide a Director with a pension of 2/3rds of the final pensionable salary – subject to a maximum fund value of €2 million.

Directors Pension Ireland

 

As a Company Director, the tax benefits are more attractive, and the scope for tax-deductible contributions much higher when made by the company than if you were to make personal contributions.

 

Here, you would be limited to the normal revenue rules which relate to age and percentage of salary (E.g., if you are age 40 its 25% of your salary), and the maximum tax relief you can claim on your contributions would be 40%.

 

When it comes to the company making the contribution on your behalf, there are a range of factors in determining how much can be contributed. These would be based on your:

 

  1. Age
  2. Salary
  3. Gender
  4. Marital status
  5. Chosen retirement age
  6. Date that salaried service commenced & potential service
  7. Value of pension benefits relating to previous & current employments

 

Tax Relief via Personal Contributions

 

Directors that choose to personally contribute to the pension can claim tax relief up to 40%, depending on their personal circumstances. Tax relief is usually claimed at the end of the tax year on a Director’s Tax Return. Personal contributions is an attractive and efficient way to reduce your personal income tax liability.

 

Maximum Contributions Allowable

For example:

Monthly pension contribution = €100. Tax relief @ 40% = €40 (employer deduction). Total net monthly cost to employee = €60

 

Investment Options

 

When setting up your executive pension there are a variety of fund options available to choose from within the product, including low, medium, and high-risk options that will enjoy tax free investment growth.

Directors Pension Ireland

 

Usually with pensions, it is considered more sensible to invest on a medium or high-risk basis when you are a long way from retirement (e.g., higher equity allocation) which gives greater possibility of return in the earlier years, and subsequently when approaching retirement, to look at reducing exposure to volatility in the markets by de-risking the investment into lower to medium risk funds.

 

When putting together a plan we will ensure the Risk Profile of pension fund is aligned with the investor’s attitude to risk.

 

When can I Draw Down on my Pension?

 

You can normally start taking your benefits from age 60 (and up to age 70). In certain circumstances, you can take benefits earlier such as if you retire from employment at age 50 or over or if you can no longer work because of a serious illness or disability.

 

Revenue usually require directors who own and control more than 20% of the voting rights in a company to dispose of their shares in the company and to cease all involvement with the company in order to draw on their Executive Pension benefits before Normal Retirement Age.

 

It is advisable, however, to drawdown your pension when you absolutely need to unless in the case that you don’t have any other source of income.

 

Pension Lump Sum:

The amount of benefits on retirement depends on the value of your fund which will depend on the level of contributions paid and the investment return earned on those contributions.

 

You are entitled to the take benefits in one of two ways:

 

Option 1:

– A once-off lump sum of up to one and a half times final salary*; and,
– The balance of the fund must be used to purchase an annuity.

 

Option 2:

– A once-off lump sum of up to 25% of the value of the assets*; and,
– The balance of the fund must be transferred to an Approved Retirement Fund (‘ARF’).

 

Death Benefits:

The value of your fund at death may be used to provide the following benefits:

 

1.  A tax free lump sum of up to four times final salary is payable to your
Estate; and/or,

 

2. The balance of the fund (if any) is used to secure an annuity for your
spouse or dependents.

 

Executive Income Protection

 

If you are looking to protect the ongoing operations of your company, Executive Income Protection is a good way of providing income security for Directors or key employees. This plan differs from personal income protection policies in that an Executive policy is owned by the company the insured works for, rather than the individual themselves.

Executive Income Protection

 

In the event of not being able to work the insured employee is then covered, with the pay-out being made to the company directly. You can then decide if the money is to be used to:

 

  1. Cover the cost of a key employee or;
  2. Be paid to the employee themselves.

 

This benefit paid by the company is not seen as a benefit-in-kind which means it is very tax efficient way of providing cover. An Executive Income Protection Policy is therefore a very attractive option for Limited companies looking for an alternative to the individual income protection policy.

 

Pension Review

 

If you already have an existing Executive Pension plan in place you need to ensure that:

 

  1. Your Pension Plan is being funded directly through the company.
  2. Your plan charges are transparent and cost-efficient.
  3. The Risk Profile of the fund and the underlying investments is in line with YOUR attitude to risk.

 

As Pension Brokers, we provide unbiased advice and compare the market for the most competitive products and offer a broad range of investment fund options.

 

The rules governing overall contributions to Executive Pensions can be complex. We recommend that you seek advice from a Financial Advisor first to make sure the company pension is set up correctly, and to maximize the overall contributions and tax-efficiency.

 

 

Need some assistance?

Fill out your details and enquiry below, and one of our Qualified Financial Advisors will get back to you shortly.

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