Turning Company Profits into Personal Wealth
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:
- 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%.
- If you take it as dividends, you would pay tax at up to 40%.
- If you use the money to buy a car for yourself, you pay Benefit in Kind at up to 30%.
- If you sell your company, you pay Capital Gains Tax at 33%.
- 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.
Transfer Company 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:
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.
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.
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 through 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 those who invest in a company pension plan enjoy benefits such as:
- No Benefit-in-kind on employer contributions.
- Immediate income tax relief on AVCs and employee contributions deducted from salary.
- Corporation tax relief on employer contributions in the year the contribution is made 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.
Benefits at Retirement
At retirement, Directors will be entitled to a Retirement Lump Sum, some or all of which may be tax free.
The balance of the fund can then be used to:
- Purchase an annuity which will provide a guaranteed pension income for life.
- Invest into an Approved Retirement Fund (ARF).
- Take as taxed cash, subject to certain restrictions.
Pension income in retirement and withdrawals from ARFs are subject to income tax, Universal Social Charge (USC) and PRSI (if applicable).
How do I get started?
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.
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