Planning Opportunities

Low Earners

For low earners in retirement who can avail of the lower rates of income tax, the optimum solution may be a portfolio of securities.

High Earners

For investments with low expected capital gains (bond funds for example) where the majority of the investment return can be expected to accrue in the form of income then an investment which is made through a fund structure is potentially the most tax efficient solution for high earners since the income would be taxed at 41% rather than the highest marginal rate of income tax of potentially 52%. (55% if self-employed with income in excess of €100,000 in a tax year).

Whereas for an investment which has a low dividend yield and where most of the return can be expected to accrue in the form of capital growth, an investment via a security would optimise the after-tax returns.

An extreme example would be a security which does not pay any dividend. Since all of the return would accrue in the form of capital gains and therefore all of the return would be subject to capital gains tax at 33% rather than exit tax at 41%..

Mixed Portfolios

Let’s assume that we expect an average annual return of 7% per annum. If we assume that half of the expected return is in the form of capital gains and half from dividends we can estimate the blended rate of tax for an investor who holds securities directly.

The gains of 3.5%pa would be taxed at 33% and the income of 3.5% would be taxed at say 52% including Universal Social Charge and PRSI at 4%. This gives an effective rate of tax of say 40% compared to 41% for investments made via funds.

From a taxation perspective these might therefore be considered to be broadly identical except that losses are allowable across securities whereas they are not allowed across funds and there is an annual capital gains tax allowance of €1,270.

These factors give a very slight advantage overall to investments made via securities rather than funds from a taxation perspective.

From this analysis, we can conclude that for a tax optimised investment portfolio that the optimum allocation between different structures (i.e. securities or funds) is that investments with low expected growth (such as bond funds) and investments with high expected income (such as high yield equities) should be held within a fund

Whereas, for investments with relatively low or zero yield and high potential for capital gains appreciation then the optimum structure would be securities rather than funds.

One Spouse Earning

Where one spouse is a non-earner, investors should consider putting the entire account in the name of the non-working spouse. This would result in a lower overall rate of USC.

Example:

Assuming a portfolio of €500,000 with a dividend yield of 2% the gross annual income would be €10,000.

As this is below €13,000, it would be exempt from USC whereas in the name of the working spouse, it might have attracted a marginal rate of USC of up to 11%.

Relative to holding the account in joint names, in this example the tax saved would be up to €550 which would offset the impact of the PRSI (see below)

Pension Considerations

For some investors, paying PRSI can increase their entitlement to the contributory State Pension.

Since this does not apply with investments subject to Exit Tax, it follows that it is important to consider the implications of the client’s tax status today as well as their State Pension record when considering the suitability of an investment contract (See Appendix 3).

In addition to considering their client’s marginal rate of income tax and any capital gains tax losses carried forward, it is important to consider the impact on the client’s State Pension of their recommendation to purchase a Life Assurance Single Premium Bond (Appendix 5)

Appendices

Appendix 1: Income Tax

StandardRateBands2022

The following standard rate bands apply:

4 Increase is lower of €27,800 and income of lower earning spouse

Appendix 2: Universal Social Charge

Married people are treated as two single people for the USC

The thresholds apply to each spouse individually and cannot be combined where one spouse is below the thresholds and the other is above the thresholds.

A couple does not have twice the €13,000 band.

Exemption limit for low income: €13,000

• If you earn €13,000 a year, you pay no USC.

• If you earn over €13,000 you pay USC on the full income at the rates above on all your income. For example, if you earned €13,500 your USC liability would be €67.50.

USC 3% Surcharge (non-PAYE income)

• The surcharge of 3% on individuals who have non-PAYE income that exceeds €100,000 in a year remains unchanged.

Whatincomeisitnotchargedon?

• Social Welfare payments

• Payments in lieu of Social Welfare e.g. CES and BTEA (Full list in Appendix A of the Revenue FAQ on the www.revenue.ie website).

• Deposit interest subject to DIRT

• Interest on Savings Certs

• Rent which qualifies for Rent a Room Relief

• Pension lump sums up to €575,000

The full list is in Appendix B of the Revenue FAQ.

Not only are these exempt, they are not used in calculating the thresholds either. For example, if you have Social Welfare payments of €10,000 and salary of €8,000, the €10,000 is completely ignored. As the €8,000 is below the threshold, no USC is payable.

USC is charged on almost all other income

• Salary

• Benefit in kind (but USC is not charged on the Travel Pass or bicycle scheme)

• Rental profits

• Self-employed income

• Pension income

• Dividends

Some income, which is exempt from tax, is liable for the USC

• Woodlands

• Patent income

• Artists' exemption

USC is charged on income before pension contributions

• While pension contributions can be deducted when calculating the taxable pay, they cannot be deducted when calculating the pay liable to the USC

Older people who earn less than €60,000 pay a maximum rate of 2%

• Individuals aged 70 years or over whose aggregate income for the year is €60,000 or less, will only pay Universal Social Charge at a maximum rate of 2%

• ‘Aggregate’ income for USC purposes does not include payments from the Dept of Social Protection.

Medical card holders who earn less than €60,000 pay a maximum rate of 2%

• Individuals in possession of a full medical card, including a Health Amendment Act card, whose aggregate income for the year is €60,000 or less, will only pay Universal Social Charge at a maximum rate of 2%. ‘Aggregate’ income for USC purposes does not include payments from the Dept of Social Protection.

Appendix 3: PRSI

Generally, persons over 16 years and under 66 years are liable to PRSI on all of their different forms of income. Generally investment income is liable to PRSI at 4% subject to a minimum payment of €500 (Tax year 2022) provided the person is a chargeable person in accordance with the Revenue definition as detailed below.

RevenueDefinitionofachargeableperson

Persons who are "chargeable persons” for income tax purposes under the Taxes Consolidation Act 1997 will be liable. A chargeable person does not include a PAYE taxpayer who: i. does not have other income or; ii. has an element of other insignificant income that is fully taxed through the Revenue Commissioners PAYE system (Revenue regard amounts not exceeding €5,0005 as insignificant. Individuals with income exceeding €5000 must pay and file under Revenue's self-assessing system).

Given that a typical bank deposit rate is now 0.01%pa this means that it is hard to imagine any saver paying PRSI on their bank interest.

“Exclusions from reckonable income

27A. For the purposes of the definition of ‘reckonable income’ in section 2(1), the following items shall not be included in reckonable income in respect of any contribution year commencing on or after 1 January 2004:

(a) any payment in respect of a foreign life policy referred to in section 730J of the Act of 1997,

(b) the amount of any gain arising on a disposal of a foreign life policy referred to in section 730K of the Act of 1997,

(c) any payment received in respect of a material interest in an offshore fund referred to in section 747D of the Act of 1997, and

(d) the amount of any gain arising in respect of a disposal of a material interest in an offshore fund referred to in section 747E of the Act of 1997.”.6

Consequently, although PRSI applies to investment income received from bank deposits, rental income or dividends, it does not apply to income or gains arising from a material interest in an “offshore fund” ie a UCITS.

5 Previously €3,174

6 http://www.irishstatutebook.ie/2004/en/si/0428.html

PRSIClasses

If you are an employee, your employer deducts your PRSI contribution from your wages. Your employer then submits your contribution and their employer's contribution to the Revenue Commissioners. Your employer must also pay social insurance on your behalf.

If you are self-employed, you pay Class S social insurance. In this case, you pay your social insurance contributions directly to the Revenue Commissioners.

If you are a PAYE worker and have unearned income of over €5,000 you are a chargeable person and you must pay 4% PRSI under Revenue's self-assessment system (Pay and File). Revenue pay the money into the Social Insurance Fund. A record of the contributions you have paid is then sent to the DEASP.

However, if your only source of income is unearned, for example, you have rental income and dividends from shares but no earned income then you will be liable to pay PRSI at Class S. Note that gains on contracts for Life Assurance subject to Exit Tax are exempt from PRSI.

Implications

Security paying dividends subject to income tax

UCITs subject to Exit Tax Life Policy subject to Exit Tax

From the table above, we can see that for some investors, paying PRSI can increase their entitlement to the contributory State Pension. Since this does not apply with investments subject to Exit Tax, it follows that an adviser needs to consider the implications of the client’s tax status today as well as their State Pension record when considering the suitability of an investment contract

Appendix 4: Capital Gains Tax

Capital Gains tax on securities is applied to capital gains at a rate of 33%.

An annual exemption of €1,270 per person per tax year is available.

Losses can be offset against gains, and losses can be carried forward indefinitely.

Note that although losses can be offset internally within a fund structure 7 they cannot be carried across from one fund management group to another. This is a significant limitation of the taxation of funds in Ireland.

The difference between the marginal rate of taxation of gains within funds and the taxation of securities represents a difference of up to 8% between the rate of capital gains tax and the highest rate of tax applicable to Funds of 41%.

7 That is to say sub-funds under the same “umbrella”

Appendix 5: State Pension

The State Pension (Contributory) is paid to people from the age of 66 who have enough Irish social insurance contributions. It is not means-tested. You can have other income and still get a State Pension (Contributory). This pension is taxable but you are unlikely to pay tax if it is your only income.

As the social insurance conditions are very complex you should apply for a State Pension (Contributory) if you have ever worked and have any contributions (stamps) paid at any time. There are a number of pro-rata pensions available to people who paid different types of social insurance contributions or who did not pay contributions because of various reasons (see below).

If you retire early, you should ensure that you continue to pay PRSI contributions or get credited contributions (if eligible) to maintain your entitlement to a pension. If you are getting Jobseeker's Benefit (JB) and are aged between 65 and 66 when your JB would normally end, you may continue to receive it until the age of 66, provided you meet the PRSI requirements.

The Department of Employment Affairs and Social Protection (DEASP) has published FAQs on Qualifying for the State Pension (Contributory) which can help you to work out whether you qualify for a State Pension (Contributory).

Rules

To qualify for a State Pension (Contributory) you must be aged 66 or over and have enough Class A, E, F,G, H, N or S social insurance contributions. You need to have:

1. Paid insurance before a certain age - you must have started to pay social insurance before the age of 56.

2. Number of paid contributions - if you reach pension age on or after 6 April 2012, you need to have 520 full-rate contributions (10 years contributions). In this case, only 260 of the 520 contributions may be voluntary contributions.

3. Average number of contributions per year - you must meet the average condition. This is probably the most complex aspect of qualifying for a State Pension (Contributory).

Normalaveragerule

The normal average rule states that you must have a yearly average of at least 10 appropriate contributions paid or credited from the year you first entered insurance or from 1953, whichever is later to the end of the tax year before you reach pension age (66).

An average of 10 entitles you to a minimum pension; you need an average of 48 to get the maximum pension.

ClaimingonbehalfofanAdultdependent-Incomelimits

For most social welfare payments your adult dependant cannot have gross weekly earnings or income (before tax and PRSI deductions) of more than €310 (€16,120).

• If your adult dependant earns less than €100 you will get a full Increase for a Qualified Adult (IQA).

• If your adult dependant earns between €100 and €310 you will get a reduced rate of IQA (sometimes called a tapered rate of IQA).

• If your adult dependant is earning more than €310 you will not get an IQA.

You can find out what the tapered rate of IQA for your payment is in the Department of Employment Affairs and Social Protection's SW19 (Rates of Payment) booklet

Creditsandhomemakers

The Homemaker's Scheme can make it easier for homemakers to qualify for a State Pension (Contributory). If you give up work to look after a child under 12 years of age, or a disabled child, or adult, you can get credits from the date you give up work to the end of that contribution year.

Rates

*Increases for qualified adults are means-tested payments

Example

Jayne is 50 years old and has taken a career break to look after her children. At this time, she has 17 years Contributory State Pension credits and 16 years to go until the State Pension age. Her children are over the age of 12. She has a joint investment with her husband of €1,000,000.

Analysis

Jayne isn’t working and so isn’t paying PRSI directly via her salary. Her children are over 12 so she is not earning credits from caring for them.

Her adviser is considering a Single Premium Investment Bond from a well-known life insurance company.

Unless she goes to work, Jayne will not earn additional State Pension entitlement. Her investment income is greater than €16,000pa and so she is not entitled to a means tested Increase for a Qualifying Adult.

How might we model the cost of arranging a life assurance contract compared to a more tax efficient solution?

We need to consider Jayne’s marginal rate of income tax and establish if there are any CGT losses which can be carried forward.

Model the effect of the State Pension: State Pension (Contributory) rates from 30th March 2018

Assuming everything else equal, the impact of missing out on additional State Pension credits is more significant for those with under 30 years of PRSI contributions at age 66.

Increase in weekly rate

More contributions (30 to 48) less contributions (10 to 30)

For example, the State Pension entitlement leaps up from €0 to €97.20 per week by increasing average PRSI contributions from 9 to 10 years.

Her maximum entitlement currently is therefore 17 qualifying years averaged over her 30 year PRSI record (see above)

The yearly average is calculated as follows:

Full rate paid contributions and credits

Total contribution years (from 1st PRSI payment to age 66)

In Jayne's example, she currently only has will potentially have 884 weeks contributions over 30 years giving an average of 61 entitled to a full state pension.

Looking at the table she therefore has 29 yearly average PRSI contributions and therefore her current entitlement to a pension is €207.10 per week compared to her maximum potential entitlement of €243.30pw

What if the net effect?

We assume a dividend yield of 2%pa on an equity portfolio of €1,000,000 generating a total gross annual dividend income of €20,000. So, Jayne’s income is €10,000pa which is more than €5,000 and so she is liable to class S PRSI at a rate of 4% on her income.

However, she has to pay 4% of her income subject to a minimum €500pa in tax that would not be payable under the Life Assurance contact (all else equal) Note that the minimum PRSA payment of €500 is another tax trap.In Jayne's case, the minimum PRSA payment is an effective rate of tax of 5% rather than the headline PRSI rate of 4%.

By triggering a liability to class S PRSI under the current rules, Jayne will increase her entitlement to the contributory State Pension by another year.

RecentchangesinStatePensions

It should also be noted that law and practice in this area is constantly changing and it would be reasonable to assume that nobody knows for certain what the rules will be in the future.

Post 2020 the method of calculation moved from the previos “total and average” basis of calculation (which allows someone with the minimum of 10 years contributions to get the full State Pension - if that’s their only PRSI record) to a system whereby each year’s contribution counts as 1/40th.

So, you now require 40 years of contribution to get the full State Pension.

Disclaimer

This document has been prepared for educational and information purposes only and does not represent a specific recommendation for an individual to follow.

Taxation

References to Taxation have been obtained from sources which we believe to be reliable and are based on our understanding of Irish Tax legislation at the time of writing. We cannot guarantee its accuracy or completeness. The rates and bases of taxation may change in the future. We recommend that you obtain specific tax advice for your own personal situation. We will refer you to a suitably qualified tax consultant on request.

Investments

As with any investment strategy, there is potential for profit as well as the possibility of loss. Past experience is not necessarily a guide to future performance. The value of investments may fall or rise against investors’ interests.

Any person acting on the information contained in this document does so at their own risk. Recommendations in this document may not be suitable for all investors. Individual circumstances should be considered before a decision to invest is taken.

Income levels from investments may fluctuate. Changes in exchange rates may have an adverse effect on the value of, or income from, investments denominated in foreign currencies.

We do not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable.

Warning: the value of your investment may do down as well as up. This service may be affected by change in currency exchange rates. Past performance is not a reliable guide to future performance.

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