Company Profits into Pension
Taking your Profits –
How Pension Contributions Can Help Business Owners
Company Profits into Pension
Many business owners will spend their time working on and in their business, with little thought for how the business is working for them. While the business may be profitable, turning that profitability into personal financial success can be an afterthought. That is why having a personal financial plan should be just as important as the business plan.
So how do clients define personal financial success? Many clients will define this as financial independence, the freedom to be able to make major financial decisions without having to worry about money. This will include when and how they exit their business and how they will fund their retirement.
If the business is sold there should be a cash lump sum available and this may be tax free if Retirement Relief can be availed of; but if it is passed on to the next generation, or there is no realisable value of the business, how do you fund your retirement independently?
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 these profits into a company pension.
Where directors take profits from the company as salary there will be an immediate tax liability. However, those who invest in a company pension plan enjoy benefits such as:
- No benefit in kind on employer
- Immediate income tax relief on AVCs and employee contributions deducted from
- Corporation tax relief on employer contributions in the year the contribution is made
In order to be eligible to take out a company pension plan the director must be set up as an employee of the company and be in receipt of Schedule E remuneration.
Let’s take a look at an example of a company director maximising his contributions:
John is 50, married and has been running his own business for 10 years. He is currently drawing a salary of €60,000 and hopes to retire in 15 years’ time at age 65. His company is currently contributing €24,000 a year into a director’s pension plan for him and it is now worth €250,000. The company is making profits of over €120,000 for the last few years and he expects this to continue. He would like to increase his pension contributions to increase his retirement fund to as close as possible to €2,000,000 at retirement.
The contribution options available to John are:
If John chooses option 1 above, and assuming that the company pays the contribution, the company can offset the full amount in the current trading year, given their profits. This would reduce the company’s corporation tax bill for the current trading year. If the company continues to make an annual contribution of €63,285 in future trading years he could offset this amount in those years potentially reducing his corporation tax bill each year.
If John chooses option 2 above, the company could offset the €48,415 a year regular contribution in the current trading year, reducing the corporation tax in this trading year. Since the single premium contribution (‘special contribution’) is greater than the regular premium contribution, the company will spread forward the relief over a number of trading years, potentially reducing the company’s corporation tax in each of those years also. The spread will depend on the particular circumstances of the company.
Spouse’s Pension Case Study
John’s wife, Joyce, is also an employee of the company and has worked part time in the business since it was set up. She is paid an annual salary of €24,000. To date no company pension has been established for Joyce. Assuming that she will have an entitlement to the maximum permissible pension fund required to provide a pension of two thirds of salary at retirement, what is the value of the pension fund that the company can provide at age 60?
Based on current annuity rates, the rate for maximum permissible annuity (5 year guarantee, 3% increase, joint life) for a 60 year old is 1.95%*. A salary of €24,000 gives a maximum pension entitlement of €16,000. A pension fund of €820,500 is required to buy this pension. Assuming that Joyce has no existing pension benefits, the company can make an annual contribution of €40,000 to her pension up to age 60 which would further reduce the company’s corporation tax bill for the current trading year and future years.
At retirement, Joyce is entitled to a lump sum from the pension, the first €200,000 being tax free. The balance of the fund can then be used to:
- Purchase an annuity which will provide a guaranteed income for life
- Invest into an Approved Retirement Fund (ARF)
- Taken as taxed cash, subject to certain
It is worth noting that where a spouse is employed in a company, Revenue will examine such arrangements to determine whether or not they have been put in place on an arms-length basis. They will want to ensure that Joyce is performing service or duties in the business for a reasonable rate of pay. Revenue Tax Briefing No.4 of 2013 sets out their requirements in more detail.
*Source: Irish Life Pensions Planet
Maximum Retirement Lump Sum Case
James is a 60-year-old Company Director who wishes to retire at age 65. He will have 25 years’ service in his current employment at age 65 but has no existing pension plan. He anticipates that his final average salary will be €65,000.
As he will have more than 20 years’ service at normal retirement age, James will be entitled to receive up to 150% of his final salary as a retirement lump sum. At age 65, James will be entitled to receive a maximum tax free retirement lump sum of €97,500 (150% of €65,000 final salary).
James targets a retirement fund of €97,500 which can then be fully drawn down with no additional tax liability or residual pension payable. The company must make annual contributions of €17,308 (€86,540 in total) to provide James with a lump sum of €97,500 at normal retirement age.
Assuming the pension option is selected, James would receive a retirement lump sum of €97,500 with no further tax liability due.
For many business owners the value they have built up in their business alongside their pension will form the basis of their retirement plan. We have looked at the generous tax reliefs available to both the company and the company director maximising the value they can transfer from the business to themselves and their family through pension funding.
Conclusion on Company profits into pension
The European Commission has put Irish economic growth at 7.3% for 2017, supported mainly by domestic activity. Many business owners are now seeing their businesses bounding ahead and their profits grow. Translating that profitability into personal financial success for your clients means taking these profits and turning them into personal wealth. The income and corporation tax reliefs available for pension contributions can help business owners take the value built up in the company to provide for themselves and their families in retirement.
To find out more please contact us on 01 2375500 or email firstname.lastname@example.org.
Emer Kirk, Head of Business Development & Marketing, Harvest Financial Services Limited. This article was published in The Financial Professional/LIA – April 2018
The marketing material is not intended to provide advice and is provided for general information purposes only.
The particular tax treatment contained herein is based on Harvest Financial Services Limited’s understanding of current Revenue practice as at July 2018. Please note that the tax treatment depends on the individual circumstances of each client and may be subject to change in the future. You should take such independent tax advice as you deem appropriate.