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Turning Company Profits into Personal Wealth

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.

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.

 

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.

 

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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 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:

 

Contribution Factors for Company Directors

 

 

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.

 

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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:

  1. No Benefit-in-kind on employer contributions.
  2. Immediate income tax relief on AVCs and employee contributions deducted from salary.
  3. Corporation tax relief on employer contributions in the year the contribution is made at the rate of corporation tax which is currently 12.5%.
  4. 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:

 

  1. Purchase an annuity which will provide a guaranteed pension income for life.
  2. Invest into an Approved Retirement Fund (ARF).
  3. 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?

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.

 

Letter of Authority:

 

In order for our Financial Advisors to review your pension benefits and advise on your options, complete the below form (using the “download” link) and send this to info@smartfinancial.ie.

 

 

 

 

 

In addition, make sure to submit your enquiry in the field below…

 

 

Need to speak with a Financial Advisor?

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

What happens to my pension when I leave a company?

 

We frequently come across this question: “What happens to my pension when I leave a company?” Nowadays people are changing jobs or even careers more frequently than they used to, and it has also become a common occurrence to leave Pension savings behind with past employers. When moving from one job to another there are many important things to consider – your Pension is certainly one of them.

 

Leaving your Pension behind may be the easier route to go but it may negatively impact your Retirement Planning if it is not incorporated with your overall long-term plan.

 

This can also be a good opportunity to sit down with a Financial Advisor to review your current financial situation and circumstances that may have potentially changed.

 

 

 

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Leaving Service Options:

 

It’s important to note that your pension benefits are managed and legally owned by the trustees of the scheme (these include but are not limited to companies like Aon, Mercer, and Willis Towers Watson), and when departing from your company your legal status will change from an ‘Active’ to a ‘Deferred’ member of the scheme. We will later assess the downsides of staying on as a ‘Deferred’ member.

 

When leaving your employer you should receive what is known as a ‘Leaving Service Options letter’, or your ‘Pension Benefits Options Statement’. This document will include important information such as the date you joined the scheme, the date you left, the value of your Pension, and finally setting out your choices available to your particular situation upon leaving. It is therefore vital that you receive this document.

 

Essentially, you have three main options when leaving your employer.

 

  1. Leave your Pension where it is (do nothing).
  2. Transfer your Pension to your new employer.
  3. Move your Pension into an account in your own name (Personal Retirement Bond / Buy-out Bond).

 

 

Option 1: Leave your Pension where it is

 

Although the easiest option, leaving your Pension behind is the least recommended particularly because Pension schemes are under no obligation to keep any engagement with you nor provide you with annual updates on how your pension is being managed or invested. Therefore, you are left in the dark without freedom to make investment decisions.

In many cases, employees Pension savings are actually moved out of investments and into cash leaving them unable to outperform inflation and the associated charges within the fund. As a result, this hinders the growth of your Pension and may set back your Retirement goals and objectives.

 

If you are considering leaving your currently employer, and are looking to review your ; we would implore you to answer the following questions:

  • Are the charges fair and transparent?
  • Is the Pension Provider responsive?
  • Has your Pension performed well?

 

If your answers to the above questions did not bode well with you then it would be wise to consider taking your Pension with you.

 

Pros:

  1. As a deferred member, you will still be able access your pension at retirement date; ie, take a tax-free lump sum; and transfer the funds into an annuity, or opt for an Approved Retirement Fund (ARF).

Cons:

  1. The Trustees of the scheme are not obligated to keep in contact with you (no regular updates).
  2. Your Retirement options are subject to the scheme rules (including early Retirement).
  3. Bigger schemes have limited Investment options since they cater for large groups of employees (your investment could under-perform).
  4. No access to Financial Advice after you have left the company.
  5. When moving jobs, you run the risk of forgetting about the plan and losing contact with it over time.
  6. Passing away before retirement could complicate matters for your dependents.

 

 

Option 2: Transfer your Pension to your new employer

 

You can consider moving your existing benefits over to your new company’s pension scheme thereby consolidating your retirement benefits, however, not all schemes allow this and you would have to check first.

 

The advantage here is that you will have everything under one roof and it will be easier to work out your overall pension benefits and how much income you would expect in retirement, rather considering a number of different pots.

 

On the downside, transferring your pension benefits would require you to sell up existing assets in order to transfer them to the new fund. This would introduce the risk of being out of the market for a considerable period, and depending on market conditions, this could mean you selling out at a lower price and buying at higher one.

 

Pros:

  1. Pension consolidation – maintaining control over your pension pot and keeping it together in one place.

Cons:

  1. You may lose accumulated rights of salary and service if you move move into the wrong type of scheme being offered.
  2. If you move jobs again, you will have to address all previous concerns and requirements of moving into new scheme.
  3. You miss the opportunity to move the fund into your own name (taking complete control over your money and Investment choice).

 

 

Option 3: Move your Pension into an account in your own name (Personal Retirement Bond / Buy-out Bond)

 

A Personal Retirement Bond (PRB) is a product that is specifically designed to take benefits from your previous employment. This includes giving you greater control to administer your own pension savings, and a better investment strategy allowing you to invest at your own attitude to risk (with added benefit of guidance from a Financial Advisor). You also have the option to move the bond from one pension provider to another if you feel you could get better value on charges, fund allocation rate, and access to funds, etc.. However, it cannot be further contributed to.

 

This route allows you to completely cut ties from your old employer, which means no more involvement of Trustees. The charging structure (Annual Management Charge) can be a higher with PRB’s depending on the funds (or asset classes) chosen but this is considered along with the performance (and active management) of the fund over time. In saying that, you will have the benefit of transparency of charges (which are more competitive than company pensions).

 

Pros:

  1. Full control over your pension and Investment decisions (fund is owned by you personally).
  2. A Financial Advisor can put together a tailored investment strategy (based on your attitude to rick) to help you reach your retirement goals and objectives.
  3. Your accumulated rights are preserved (salary and service details recorded) giving you access to your tax-free lump sum entitlement, and increasing your options to draw on retirement.
  4. Move your PRB from one provider to another efficiently.
  5. Your benefits can be taken from age 50 (as with the company scheme).

 

Cons:

  1. Annual Management Charges can be higher depending on the funds/assets classes chosen.

 

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What do we recommend?

 

In most cases, the Personal Retirement Bond is the most practical route, it is a simple, straightforward way to take your pension entitlement with you when you change jobs. The Pension savings that you have built up are yours, so why not take personal control of the assets you own.

 

With the ongoing support of our Financial Advisors, we will first establish if this is the right option for you, and if so, we can help guide you through the Pension transfer process and ensure that the funds are set up correctly, managed effectively, and monitored continuously!

 

 

How do I begin the transfer process from my old employer?

 

If you are currently planning on leaving your employer or looking to take old pension benefits that were previously  left behind, you will need to contact the HR Department at the company and request your ‘Leaving Service Options.

 

The HR department or pension administrator will make a request to the trustees on your behalf to issue you with your ‘Leaving Service Options Letter‘ outlining the current value of your benefits and your available options.

 

Letter of Authority:

Contact us for Financial Advice

 

In order for our Financial Advisors to review your pension benefits and advise you on your options, complete the below form (using the “download” link) and send this to info@smartfinancial.ie.

 

 

 

 

 

In addition, make sure to submit your enquiry in the field below…

 

 

Need to speak with a Financial Advisor?

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