Three changes in last week's Budget which should be of fundamental interest to many readers are: the intention to introduce reforms to the way personal pensions can be funded and annuities purchased; the adjustments to inheritance and gift tax rules; and the doubling of the tax liability on profits from Special Investment Accounts and the introduction of withholding tax on share dividend payments.
The proposed pension changes are the first real indication since the publication of the report of the National Pensions Policy Initiative last May that the Government has seriously considered some of the suggested reforms to personal pension funding and the deficiencies of compulsory annuity purchase at retirement.
From April 6th, the Minister for Finance, Mr McCreevy intends that the current 15 per cent funding limit for personal pensions (20 per cent only if you are over 55) will be replaced with a sliding scale of contributions. Up to age 30, a personal pension fund holder will be able to contribute up to 15 per cent of their net relevant earnings; from age 30 to 40, up to 20 per cent; from age 40 to 50, 25 per cent and from 50 and over, up to 30 per cent.
This is a highly significant move since the majority of self-employed people tend only to begin saving in a pension fund in their late 30s or 40s.
A 20-year investment frame, restricted as it has been by such a sharp limit on contributions, is simply not enough time to produce a pension income that is anywhere near the equivalent of what could be produced by an occupational pension fund, where these sorts of limits do not apply. "The 15 per cent limit is a throwback to the days when the self-employed were mainly professionals who, it was assumed, would keep working as lawyers or dentists or doctors 'til the day they died," says one accountant. "But practically no one wants to have to be working in their 70s or 80s."
Today, self-employed people form a much wider social group and should not be penalised for only starting their pensions in their 40s, when their incomes may, for the first time, be sufficient finally to invest in a pension.
The only concern being expressed about the intentions of the Minister for Finance is that he said he was considering putting up an earnings ceiling under which pension contributions would be limited.
A spokesman for The Irish Association of Pension Funds (IAPF) told Family Money that an earnings ceiling would defeat the purpose of the higher contributions level and that, after all, the more money poured into a pension fund, the more would eventually be drawn down as income, which would be subject to full income tax.
On the matter of pension annuities, the Minister intends that the self-employed will no longer have to buy an annuity at retirement date. Instead, they will be permitted to draw down some of their pension fund before they are obliged finally to purchase the annuity. The IAPF, which welcomed the measure, did, however, express concern about the risks associated with pensioners drawing down cash from their pension funds and possibly ending up destitute in their old age.
The association's spokesman said a number of details, such as what percentage of the fund could be drawn down every year, how to ensure that the retired person's fund was invested properly until the annuity was purchased, and finally, the age at which a person would ultimately have to buy the annuity (say, between age 70-75) would need to be carefully worked out before next April.
Tying up what could be a very large pension fund in an annuity at 60 or 65 is an increasingly contentious issue as more people question the fairness of annuities/pension income dying with the retiree, rather than reverting to next-of-kin as part of their estate. It is becoming more common for retirees when buying their annuity to include an income guarantee, which means that their full pension will continue to be paid to their spouse or heirs for at least five years after their death. But this is a pricey option and will reduce the income that is paid. If there is no guarantee, only the designated spouse's or dependant's pension will be paid. If there is no spouse, and the retiree dies, (even soon after he/she retires) the pension dies with them.
The most significant point of these changes is that retirees will no longer have to buy an annuity when interest rates are low and gilt prices high, as they are at the moment, thereby committing themselves and often their spouses to an income for life that may have been far better if they had just been able to wait a few months or even years for a more favourable investment "window". Being able to draw down, say, 5-6 per cent of their pension fund each year, may be sufficient in some cases to fund the early retirement period when a younger spouse may still be working or when the retiree's opportunity for part-time work is still a reality. As the IAPF has suggested, it will be important not just to set a prudent draw-down limit, but to ensure that the remaining fund is invested prudently, with a significant portion directed into fixed interest assets such as cash and gilts and the balance in a safe basket of shares.
The changes announced in the Budget for inheritances and gifting of assets are also good news for anyone who has received such a bequest since 1988. The Minister decided that the way Capital Acquisition Tax was calculated when someone received more than one bequest in their lifetime needed to be updated. Up to now all gifts and inheritances received since 1982 have been aggregated, that is, taken on an accumulating basis - and would have had an impact on a person's tax-free threshold over the course of their lifetime.
For example, if you inherited a sum from an aunt in 1982 and another amount from a parent in 1990 - even though both amounts fell within the limits of your tax-free threshold for both categories of relation, you could still end up paying a higher amount of tax on the inheritance from the parent, than if you had not received the first inheritance. The point from which inheritances or gifts are now aggregated has now been pushed forward to 1988; before this date any previous inheritances will not be taken into account for the calculation of your CAT. The Minister also increased the exemption limit for tax payable on all gifts from £500 to £1,000; the last time the limit was changed was 1978. Given the state of inflation over the period, however, financial advisers suggest that even doubling the limit is not proportionate to the real change in the value of money in the intervening period.
In last year's budget, anyone with shares was given a huge bonus by the Minister when he halved the Capital Gains Tax on profits from the sale of shares. This year, because he reduced corporation tax, he has decided that share owners will have to pay tax on their dividends up front, in the form of a withholding tax of 24 per cent. Anyone paying tax at the higher rate will still have to declare their share profits on their annual income tax return.
For elderly people relying on this share income, the new measure could have a significant effect on cashflow, say advisers, though if their income is below the overall income tax threshold they should be able to claim it back.
Finally, the doubling of tax from 10 to 20 per cent on Special Investment Accounts came as something of a surprise to many financial advisers who had been advocating SIAs as a low to medium risk investment alternative to low yielding deposit accounts.
The SIAs are sold by life assurers and require that 40 per cent of the fund be invested in Irish equities in year one, rising to 55 per cent by year four. Six per cent of this portfolio must be in "smaller" Irish companies with a market value of at least £100 million. The balance can then be invested in safer assets such as gilts or cash. A pure equities version - the Special Portfolio Investment Account - is operated by stock brokers; what the two have in common is the 10 per cent tax on the investment fund or dividends.
By doubling the tax take on the SIAs, these accounts may lose some of their appeal, according to advisers, especially since there are other set-up costs as well. The alternative is to invest directly in equities, pay the 20 per cent withholding tax and CGT on dividends and profits, but save on the lower broker commission. "This is a riskier course, and one that elderly people may not be so happy about," one broker suggested. "But this Budget shows that the Minister is moving towards a level playing field for all types of investments."
