Tax-efficient products allow SSIA holders to make long-term savings, writes Laura Slattery
The 25 per cent bonus paid on savings made through Special Savings Incentive Accounts (SSIAs) might be unprecedented over a five-year term, but forward-thinking savers have always benefited from an even greater financial offer: tax relief on pension contributions.
Pensions savers receive income tax relief of either 20 per cent or 42 per cent, depending on the rate at which they pay tax. If they are contributing to the pension through payroll at work, they also receive relief from PRSI and the health levy, a further 6 per cent relief.
But pensions are not very popular. Personal Retirement Savings Accounts (PRSAs), introduced in 2003 to increase the number of people covered by a private pension arrangement, failed to capture the public's imagination in the same way that SSIAs did.
This has prompted both the pensions industry and the Government to conclude two things: that a new type of pension giving consumers limited access to their savings before they reach retirement should be considered and that consumers more readily understand the value of a matching contribution or State bonus than they do tax relief.
The Government is still humming and hawing about introducing a flexible-access pension, but it has already expanded the idea of SSIA-style bonuses to pensions in a bid to encourage SSIA savers to reinvest their nest eggs for the long term.
In the last budget, Minister for Finance Brian Cowen made an undertaking to pay people whose annual income is less than €50,000 a bonus of €1 for every €3 transferred directly from the SSIA into a pension within three months of the SSIA maturing.
The maximum bonus paid is €2,500, meaning that people who reinvest €7,500 will get the full value of the offer.
The Government will also pay an additional tax credit based on the proportion of the SSIA invested: if all of the SSIA is reinvested, the tax credit will equal 100 per cent of the exit tax deducted from the account. If half of the SSIA is reinvested, half of the exit tax will be credited to the pension.
The initiative is aimed at people who are paying tax at the standard 20 per cent rate and people who are outside the tax net who have traditionally not had as great an incentive to contribute to a pension as 42 per cent taxpayers.
The Revenue recently removed the condition that people must not pay any tax at the 42 per cent rate to avail of the offer and said it was now open to anyone earning less than €50,000 in the year before the SSIA matures.
But as income tax relief cannot be claimed on the SSIA lump sums under the normal pensions rules, the €1 for €3 offer has no benefit for higher rate taxpayers. They should avoid the scheme as they will be better off getting 42 per cent tax relief on their usual pension contributions.
As a result of the normal reliefs from tax, PRSI and the health levy, a pension contribution of €100 only costs an employee who pays tax at the 42 per cent rate a net €52.
With 900,000 workers not covered by a private pension, the value of this tax relief is either being sneezed at or is simply not clear to people, some of whom jumped to take advantage of the SSIA scheme.
The main difference between pensions and SSIAs is that people have to wait decades to enjoy the benefit of saving under a pension. With SSIAs, the term was a manageable five years. But that wasn't the only difference.
Unlike SSIAs, which were open to people saving a minimum of €12.70 a month, pensions are expensive to fund, especially if there is no employer matching workers' contributions.
Research conducted on behalf of the Pensions Board points to the problem: 21 per cent of people who are not contributing to a pension say that they simply cannot afford to do so. On personal pensions, insurance companies help themselves to as much as 50 per cent of the first year's contribution and regular ongoing fees and commissions disappeared out of savers' funds, often without being disclosed. Aware of the difficulties for younger people with other demands on their budgets, the Pensions Board introduced the PRSA.
Charges were capped on standard PRSAs to make them better value than the old-style personal pensions, while the minimum contribution was set at just €300 a year, regardless of whether or not that was enough to generate an adequate pension.
Consumers were supposed to be able to stop and start contributions when they wished.
However, some PRSA providers decided to raise the bar by refusing to pay commission to brokers on contributions below €150 a month, reducing the flexibility of the products for people who wanted to receive independent financial advice before buying. For those who can afford them, pensions are highly tax efficient. Apart from the relief on contributions, there is no capital gains tax on the investment and part of the fund may be drawn down tax-free on retirement.
According to Deloitte Pensions & Investments, reinvesting SSIA lump sums into a pension makes financial and tax sense. "Particularly for employees who may not already be making additional voluntary contributions (AVCs) when their SSIA matures, it may be invested by way of a lump sum into an AVC," according to the latest edition of Deloitte's Money Brief.
And once their account matures, SSIA holders will suddenly have up to €254 a month extra that they didn't have for the previous five years. This will free up more cash to make AVCs through their payroll at work.
For some people, pensions are far too constricting a prospect and they would much rather invest in property, even if the tax breaks on property are slowly drying up.
But this week, Standard Life launched a new pension product that allows people to invest in property through their pension and take advantage of the associated tax reliefs.
High net worth investors could already do this, but Standard Life has widened the market by accepting low minimum contributions and allowing people to band together in syndicates to buy residential and commercial property here and in the UK, leveraging their investment with borrowings within the pension.
Thousands of SSIA accounts were opened on the last day it was possible to do so, way back in April 2002.
But a pensions investment is not something that should be done at the last minute, according to Standard Life's chief executive in Ireland, Michael Leahy, who says that a little forward planning will help keep things tax efficient.
By investing in a pension before November's income tax deadline, investors can backdate their contributions to last year. If they hold off contributing some of their SSIA lump sum until the following January 1st, they can split their investment over three years. This will ensure that the lump sum investment in the pension won't exceed the annual tax relief limits on pensions contributions, which are based on a percentage of net income and increase with age.
A lump sum contribution of €40,000 won't cost much more than €20,000 - around the same amount someone who contributed the maximum €254 a month to an SSIA for the full five years will have.
"You can almost double your SSIA money if you can get it into a pension," Leahy notes - not a bad return if you can stand waiting until retirement to get your hands on the money.
