It is well established that company pension schemes are an attractive and tax efficient way for company directors to convert corporate profits into personal wealth through the mechanism of a company pension scheme. Whilst most are aware of the generous maximum funding rates available it seems there is less awareness of the fact that it is possible to compress pension funding into a shorter time frame through the use of Special Contributions.
There are two types of Special Contributions i.e. Employer Special Contributions and Employee Special Contributions. This report will focus exclusively on Employer Special Contributions. This ability to make Special Contributions is most commonly utilised when individuals are close to retirement age.
However their application is not just limited to those approaching retirement age, rather it can be utilised for any individual who has a gap in pension funding. What does ‘a gap in pension funding’ actually mean? Very simply a funding gap occurs if there is a gap between the pension fund that is currently in place and the fund that could be in place.
This gap can be plugged by once off contributions referred to as Special Contributions. The Government through generous tax breaks afforded to company pension contributions have sought to reinforce the message that it is never too late to make pension provisions to plug any funding gaps. However be aware that a Special Contribution cannot be made to provide benefits for future service so where an individual has just started service or has short service there may well be little or no scope to make a Special Contribution.
Employer special contributions
Employer Special Contributions can be made on behalf of directors or employees though realistically they are usually made on behalf of proprietary directors. Different rules apply to tax relief on special contributions. Tax relief may be given either:-
- In the chargeable period in which the contribution is paid, or
- May be spread forward over “such period of years as the Commissioners think fit”.
Current Revenue practice is to spread relief on employer special contributions forward over a maximum period of five years. No spreading of tax relief is required where the special contribution does not exceed the greater of:-
- The employers ordinary annual contribution, and
This effectively means that a special contribution up to the ordinary annual contribution can normally qualify for tax relief in the chargeable period in which it is paid.
Where the special contribution exceeds the greater of €6,350 and the ordinary annual contribution relief may be spread forward to a maximum of five years, subject to a minimum divisor of €6350.
N.B. In determining whether an employer’s special contribution needs to be spread forward or not, it is important to bear in mind that it is the aggregate of all contributions, made by an employer to exempt approved schemes, that is taken into account.
- What if the director hasn’t availed of maximum funding opportunities at any time during employment?
- A Company may make a one off special contribution to fund for maximum benefits.
- The payment attracts tax relief, which may be spread forward up to a maximum of 5 years.
- Director may then exercise Finance Act 1999/2000 options.
Applicability at the point of retirement
What if a director at the point of retirement or indeed at any other time hasn’t availed of the maximum funding opportunities, yet their company has a significant amount of money sitting in company accounts? Can this money at this late stage be extracted in a tax efficient manner and placed in personal ownership?
The answer is yes, through a company pension arrangement and then through the Approved Retirement Fund (ARF) mechanism. Employers may make whatever contribution is/are necessary to build up a pension fund which will provide their directors/employees who have at least 10 years service with a pension of 2/3 final salary, plus 100% widows/dependants pension plus the annual escalation in the value of these pensions to offset the increases in the cost of living during their retirement.
Thus the amount of money a company can contribute and claim tax relief on is enormous. Pension funding does not have to be thought of as a process to be undertaken over the entire working life of the director. Instead cash flow permitting pension funding could be dealt with in its entirety at the point of retirement.
But of course it is not just at the point of retirement that once off funding has applicability and in fact I have been involved in cases where once off pension funding was utilised in connection with Retirement Relief. In these situations the scope for large once off contributions has been effectively used in conjunction with Retirement Relief to minimise tax exposure on the sale of the business. A full exploration of this area is beyond the scope of this article but if any queries feel free to contact me.
Scenario: Director married aged 60 and has current pension fund of circa €1,000,000.
Salary €100,000 and 10 years service
Questions: Is there scope for additional funding?
When can Pension Fund be accessed?
- Maximum permitted funding, based on salary of €100,000 would take the client to the maximum fund of €2,000,000
- Thus scope for proposed additional funding of €1,000,000.
- How can we maximise the funding opportunity?
- Company is allowed to make a special contribution at retirement into Directors Pension Fund, to purchase maximum benefits and gain tax relief.
- Company makes a single premium payment of €1,000,000.
- Director accesses benefits at normal retirement age so if desired no need to actually stop working or sell shareholding.
- 25% of €2,000,000 is paid out tax efficiently equating to €440,000 (first €200,000 tax free with balance of €300,000 taxed at standard rate).
- Balance of €1,500,000 is invested between Approved Minimum Retirement Fund and an Approved Retirement Fund,
This article has primarily sought to focus on how employer Special Contributions afford the company the opportunity to significantly enhance a directors pension benefits, whilst availing of tax breaks.
Special Contributions augment existing pension arrangements by allowing proprietary directors to use excess profits to top up their pension funding. With such high funding rates the level of profit that can be transferred in this manner is enormous. This allows huge flexibility in terms of profit distribution.
In essence the ability through generous maximum funding rates to compress pension funding into a short time frame with full tax relief on contributions (subject to criteria) coupled with the above listed advantages make the possibility of Special Contributions a very attractive proposition to both director and company.
If you have any questions in relation to this article or if you need help in solving any other financial problem you are more than welcome to contact me.