Time for Government to stop eroding retiree’s income 

As published in the Sunday Business Post,  23 March 2024

The Irish pension landscape is undergoing significant change from the rollout of new regulations and governance standards to the imminent launch of auto-enrolment.

Yet, one aspect of the system appears frozen in time. And it is one that exerts a significant influence on the ability of Irish organisations to attract and retain the most talented individuals at senior levels.

The Standard Fund Threshold (SFT) is the ceiling above which an individual’s combined pensions arrangements incur chargeable excess tax at 40%. This tax is in addition to the marginal rate and USC applied to any income drawn from the pension in retirement, creating an effective tax rate of 70% for assets over the threshold.

First introduced in 2005 and set at €5 million, the SFT was launched in response to individuals accumulating excessive levels of wealth in their pensions and availing of tax relief on the full amount. The legislation at that time suggested the threshold would be reviewed and, where appropriate, adjusted in line with annual average wage growth for the preceding year.

Accordingly, the SFT was increased in 2007 and 2008 and then reduced to €2.3 million after the financial crisis, before falling to €2 million in 2014. And there it has remained despite a 21% cumulative increase in inflation and a 30% increase in wage growth over that period.

After many years of pension industry professionals and public servants calling for the threshold to be increased, the Department of Finance recently announced a consultation process on the current regime. Expected to conclude in 2024, this examination of the SFT is long overdue.

Recent high-profile retention and recruitment issues in the public sector prompted the review – most notably the difficulty in attracting senior gardaí to apply for the Deputy Commissioner role due to concerns over potential future tax bills related to pensions. These issues, of course, are not new, having affected medical professionals and judges for years. Neither are they unique to Ireland. Similar problems in the UK, for example, recently led to Chancellor Jeremy Hunt abolishing the pension lifetime allowance limit – the UK equivalent to the SFT.

In this context, it is difficult to see how the Irish government’s current stance of keeping the SFT stagnant is tenable as experienced and valuable public servants retire early to avoid incurring penal taxes on their retirement assets.

Similar challenges exist in the private sector and any adjustment to the SFT should address both equally. A higher proportion of the private sector workforce are now on course to breach the SFT as more individuals understand the importance of saving for an adequate retirement and the financial risks involved in living longer. The government has consistently promoted the concept of pension adequacy and the need to save for a desired standard of living in retirement, yet the SFT and the failure to increase it contradicts that message.

The reality is that the SFT limit, after a tax-free lump sum is taken, allows for an income of around €60,000 in retirement. While this is undoubtedly a sizable amount for many retirees, it is far from excessive when such things as nursing home costs or increased mobility and activity in retirement are considered. The truth is that pension savers should be aiming for this level of income to safeguard their standard of living and protect against longevity risk. Instead, the SFT detracts from this message and can lead to issues in attracting and retaining highly skilled talent. In some cases individuals may actually choose to retire early or move overseas to avoid being directly impacted.

It is also important to remember that, for the most part, these individuals are essentially deferring payment of income tax at their marginal rate now to pay it later in retirement.

It appears the original intention of the SFT was that it would be adjusted in line with wage growth, but due to significant events i.e. the financial crises, the government pivoted away from that position. However, a decade on, it is time for the government to stop eroding the true value of retiree’s income and return to that original position.

Whatever happens to the threshold as a result of the government consultation, employers and employees need to have an SFT strategy and understand the options available to them. For employers, this may involve monitoring employees on that trajectory or providing alternative remuneration arrangements such as redirecting contributions to a savings plan. These strategies may also deter experienced individuals from retiring early, helping employers retain valued workers.

For employees, business owners, and other individuals on course to hit the SFT limit, it is vital to take financial advice on the options available. A number of wealth management solutions can help manage any potential tax bill. For those affected, it is important to consider the issue and start a conversation well before reaching the limit.

Fergus Moyles is Head of Private Wealth Strategy at Mercer Ireland.