The Fund Cap - read the fine print

The 2011 Budget was clearly focused on getting our financial house in order. I think everyone accepts that pain was inevitable and we are all happy to grin and bear it if the pain is distributed equitably.

However in some instances the budget fails in this regard.

A classic example is in relation to the new Fund Threshold of €2.3m. On first glance this appears equitable. It applies to all benefits whether public sector or private sector or whether defined benefit or defined contribution.

However the devil as they say is in the detail.

For private sector workers with defined contribution benefits it is easy enough to apply the cap – the capital value of their fund is whatever it is worth at the relevant time. For public sector workers things are slightly more complicated. Because their benefits aren’t funded in advance their entitlements are generally expressed in income rather than capital terms. Thus a public servant retiring on a salary of €200,000 will typically have an entitlement to a pension of €100,000 per annum increasing in line with earnings.

What is the equivalent fund value?

The government takes a simple approach and simply says multiply the benefit by 20. Thus the official value of this benefit is €2m and the limit isn’t breached.

However this approach undervalues the cost of the benefit.

Under the funding table published by the Revenue in relation to private sector workers a factor of 32.4 applies to a male age 60 with an entitlement to a spouses benefit. This would generate a value of €3.24m for the public servants pension.

In practice however the Revenue table is only designed to capture normal private sector benefits. In particular it doesn’t have the ability to capture a pension benefit that has the potential to increase in the future in line with earnings. In practice this is a much more expensive benefit and would result in a conversion factor of 40.

Thus the market value of this public servants pension is €4m.

This may seem like an incidental matter. However the overall value of this concession to this civil servant is €697,000.

When all other tax breaks are being closed down it may seem strange to see the government creating a new one. But then the only people that will benefit from this are senior civil servants and government Ministers.

Aidan McLoughlin

Creditor protection of ARFs

Recently various commentators have made the argument that ARFs do not enjoy protection against creditors because ARF funds are personally owned property of the individual and not protected by trust law. I recently saw this view forwarded by the Pensions Ombudsman and (too) readily accepted by commentators.

Whatever about the accuracy of this idea – ARFs can also be established under trust and enjoy protection of trust law – I find it baffling that commentators without discussion willingly accept that providing for retirement in good times is an idea which may be challenged by your creditors when things get bad.

Compare the regime protecting an individual’s transfer of assets to the spouse. Such transactions are, subject to certain criteria, protected by the courts. They are even encouraged by legislation as there is no CAT and no stamp duty. One has got to ask oneself why funds that you set aside for the honourable purpose of not being a burden to the State in retirement shouldn’t be protected while funds siphoned off to the missus is. I don’t see any reason for this.

And whatever the media may want to make you believe, there is no Irish case law to confirm that creditors may come after ARF funds, not even the recent Brendan Murtagh case. In that case it is reported that Mr Murtagh’s lawyers without argument made his ARF funds available to pay his debts.

The ARF regime is an innovative way of dealing with the annuity problem. Why commentators are so willing to sacrifice it when there are many laudable reasons to protect it, is beyond me but then again, the insurance industry never liked ARFs. I also think that the argument is fundamentally flawed. ARFs are protected, subject to certain conditions.

Tommy Nielsen

Budget 2010 – Good for some?

Much will be written over the next few days on the details of the budget. However it is sometimes useful to stand back and take a wider view of matters. What will the long lasting impact of this budget be?

The first impression that comes to mind for me is – an opportunity lost.

Everyone accepts that we needed to alter our finances to put things on a more stable footing.

However the opportunity to make some long-lasting changes appears to have been missed. The measures on pensions, property and employment smack of short term raids and incentives rather than a longer term realignment of priorities, broadening of the tax base and control of expenditures.

The second thought that strikes me is – can you ever trust the government again? Those that invested in a vast array of tax incentives are seeing those tax breaks ended prematurely with the promised relief curtailed. What impact will that have on future tax breaks e.g. the new improved BES scheme?

A final thought relates to the public sector – particularly the golden generation that joined the service before 1995. These individuals will continue to enjoy pension benefits far beyond those enjoyed in the private sector. The capitalised value of these mushroomed from €75bn in 2007 to €129bn in 2009 – an increase of approximately €145,000 per person. The 4% reduction now proposed is only a drop in the ocean compared to liabilities that grew by €54bn in the last two years alone. If we genuinely are all returning to 2007 living standards surely we should have “gained” another €50bn?

The lasting impression therefore is one of sadness – Animal Farm is alive and well in Ireland.

“Relief “ here today but gone …………

CAT 

Relief from gift/inheritance tax was generous in the tiger years, the tax-free thresholds available had increased significantly in acknowledgement of the increasing asset values. The intentions were clear at the time, so we shouldn’t be surprised that some (or many) of these measures will be reversed.

The sting in the tail of course will be that if, or when, we do see recovery in asset values in this country, we are unlikely to be in a position to access reliefs to the same degree again. While the 4-year plan doesn’t go into  detail, we can probably assume that the report of the Commission on Taxation, relegated to the bin shortly after publication, has been dusted off and will provide the inspiration for reforms. Taking that in account means that family businesses, including farming families, will pay a higher price when those assets are transferred. To put this in context, a family business worth €6m, which is gifted to three children could move from a minimum tax cost today of €60,000 to €810,000. The plan itself seems to suggest that reforms will take place in 2012, but we can certainly assume that the tax-free thresholds will suffer a further decrease in January when adjusted for inflation (or rather, deflation.)

CGT

Charlie McCreevy reduced the capital gains tax rate to 20%, but did remove many of the reliefs available, really leaving the business related relief intact. This too will suffer, most likely with the imposition of a value cap on the benefit that can be derived from it. Many asset disposals in the coming years will be the subject of capital losses, rather than gains, and so it may be some time before changes in this area start to bite, although changes may be harsh depending on the levels at which differing rates of tax will apply.

Stamp Duty

Finally, to stamp duty, really the most regressive of them all, penalizing families trading-up or trading down in many circumstances. The reality is that the government rode the boom on this one, with stamp duties contributing €3bn to the economy in 2006 and 2007. Calls for reductions or abolition widely ignored, the government really did pander to (and continues to) the construction industry by ensuring that newly-constructed homes benefited from exemptions or reliefs to a far greater degree than second-hand, assisting the release of VAT into the system at the same time. Now everything is frozen, no stamp duty, no windfalls of VAT. There is no commitment to abolish this duty, rather a commitment to abolish the reliefs and exemptions that are currently available.

Is this government really, seriously, going to try to increase effective rates of stamp duty on significantly reduced levels of transactions? Stamp duty receipts in 2010 are 5% of what they were in 2007. Is there any understanding of the impact of this? Although maybe, just maybe, there is a shining light somewhere and the government is waiting to publish some good news in the upcoming budget.

It would appear that there may still be some time left to plan around some of these provisions. The only thing that’s certain is that we won’t know the full impact of changes for 2011 until December 7^th.

For further commentary on the National Recovery Plan, see our website

Pension savings still the best tax break but planning is essential

The National Recovery Plan has received a lot of bad press but from a pension savings point of view there is some good news!

Whilst the government has indicated some significant changes to pensions it has also indicated a willingness to talk to the industry. In particular some of the points made by Aidan McLoughlin when he appeared before the Finance Committee of the Oireachtas are reflected in the Plan  itself:

1.                   The figures bandied about for tax relief are not properly understood

2.                   Pensions tax relief is actually only a form of tax deferral

3.                   Pensions have a key role to play in terms of investing in the economy

On the negative side the Plan suggests that tax reliefs on contributions made by the employee, to include AVCs, will be curtailed. A phased introduction of income tax relief for employee contributions is anticipated. The marginal rate will over a period until 2014 be reduced to the standard rate of 20% for everybody. In addition, the relief from PRSI and health levy for employee contributions will be abolished. It is also significant that the €150,000 earnings cap which determines the maximum tax deductible pension contribution is to be reduced to €115,000.

The good news for most pension holders is that they can continue to avail of the existing reliefs in relation to pension contributions made by their employer. Contributions may be made by the employer before corporation tax and are not taxed in the hands of the employee.

While there are very few commitments in the Plan to not increase taxation in specific areas, significantly in the domain of pensions relief, the Government pledges not to make pension contributions made by the employer subject to Benefit-In-Kind for the employee.  This basically gives certainty to those who continue to plan for retirement reassurance that they may continue to avail of tax relief.

We believe this will impact significantly on the design of remuneration packages for the future.

The Plan however does have a negative impact on the reliefs available on retirement. It is anticipated that the max tax free lump sum available on retirement be set at €200,000. Furthermore, the standard fund threshold which is the max funding which can be achieved tax-free in all your pension arrangements will be reduced from the current €5.4 million to a yet unspecified level.

Both of these are extremely retrograde steps with no revenue raising potential for the State. At a time when we Ireland is trying to attract multinational headquarters and high tech business it is critical that key decision makers in those enterprises aren’t discouraged. It is to be hoped that the discussions with the industry will allow sanity to prevail on this point.

Will the Budget come early?

Rumours are circulating again that it may be necessary to publish more specific details of the taxation increases and expenditure cuts in the Budget, scheduled to occur on Tuesday 7th December. 

If it happens that more specific details of the economic measures have to be published, the argument goes that it may be necessary to actually introduce the Budget early to prevent people taking avoiding actions.

Rumours are just that – rumours.  This one has been doing the rounds for a few weeks now. Having said that we are in uncharted water in terms of what may happen with regard to government finances so nothing should be ruled out. The sensible thing for advisors to do would be to advise clients to immediately put in place whatever actions they were planning to in any event. 

Charity Begins At Home

The turmoil in government bond markets in recent times has highlighted the degree to which the international investment community is skeptical about investing in Ireland. Should we be surprised at this?

Put another way - would we invest in Ireland?

In the context of pension funds at least the answer appears to be no.

Major economies such as the US, UK, Canada and Australia have, on average, invested 25% of their pension funds in domestic equities. In Ireland the equivalent level of investment is 5%.

European countries have a high proportion of their pension funds invested in domestic bonds. In Ireland, the National Pension Reserve Fund has 0% invested in domestic government bonds – it is legally prohibited from having a greater stake of investment.

There are many good reasons why this should be so – risk diversification, the small scale of the Irish market etc.

For example the liabilities of Irish pension funds are calculated primarily by reference to German bond yields – therefore such funds must invest in German bonds rather than Irish bonds when matching liabilities. This contributes to the ever increasing yield gap between Irish and German Bonds.

Whilst the causes are explainable the fundamental point remains – the recovery of the Irish economy will ultimately be dependent on Investment in Ireland.

And for various reasons the legal and tax systems for pensions prevents this happening in Ireland to the same extent as it happens in other developed economies.

If an additional 5% of Irish pension funds could be encouraged to invest in domestic business it would represent a boost of €3.6bn in capital inflows.

Double that to 10% and you are looking at matching the famous deal Albert Reynolds did with Jacques Delors in 1993 to kick-start the Celtic Tiger.

It is said that charity begins at home. Is the same not true for investment?

The Scales of Inequity

An Independent Trustee Company study reveals costs up to €35,000 a month to fund each Minister’s pension.

According to the report, whilst a self-employed entrepreneur has to toil for 40 years and generally make significant and often unaffordable monthly contributions to their pension funds, Ministers only have to serve 10 years in the role to achieve pensions worth up to €6,870,504.

The Scales of Inequity



Tommy Nielsen comments that “presently, a Minister who has served 10 years is entitled to a pension of 60% of his salary, which is applicable even if that Minister were to retire from his position at 50 years of age. For a private sector worker to deliver such a pension, they would need to build up a pension fund of €6,870,504. This would require pension contributions of approx. €35,149 every month. This figure is effectively what it costs  the taxpayer  to fund these Ministerial pensions - on top of a Minister’s salary which is just under €200,000 and their expenses which have been subject to such media interest”.

Independent Trustee Company’s study looks at the relative value of these benefits and the comparative cost if these were provided under a regular private sector pension.

Ministerial Pension Benefit
Age of Retirement	New Scheme Pension Entitlements		Salary	Capitalised Cost @ CPI escalation	Est. Monthly contribution required
	Minimum	Maximum		Maximum
50	20%	60%	€191,000	€6,870,504	€35,149
55	20%	60%	€191,000	€5,787,879	€29,610
60	20%	60%	€191,000	€4,786,967	€24,490
65	20%	60%	€191,000	€3,875,550	€19,827
Notes:
Based on Annuity Quotes as at 11.10.2010
Assume Male, Married (with 50% spouses pension)
Salary of €191k w.e.f. Dec 2009

If Ministers’ pension benefits were to be subject to benefit-in-kind, it would wipe out their entire salary and they would receive a bill rather than a salary every month.

Entrepreneurs Pension Benefit
In comparison a self-employed entrepreneur must fund the entire cost of the pension benefit out of their own funds – subject only to the benefit of tax relief on contributions.

There is a stark difference between the two benefits with the Minister being provided with a guaranteed benefit which is more than 10 times what an entrepreneur paying maximum contributions can hope to get in unguaranteed format.

For further information log onto the news section of our website:

Full press release
Media coverage
Interview on NewsTalk

Interview following presentation to Oireachtas Committee for Finance

If you have difficulty viewing this video, click here to view or here for website

Family Businesses – backbone of the economy

http://www.hbo.com/the-sopranos/index.html

Currently there are a number of very valuable tax reliefs which allow for the transfer of business assets from one generation to the next, in particular CGT retirement relief and CAT business property relief. 

These are extremely important in ensuring that business transfers do not result in the destruction of the business – to the detriment of the economy and employees.

Provided the relevant conditions are satisfied, the transfer of business from a parent to a child (which includes a step-child, a child of a deceased child or a working nephew/niece) can be done free of CGT and the taxable value of relevant business assets is reduced by 90% for CAT purposes. The assets need to be retained for 6 years after the transfer.

The bad news is last year’s Commission on Taxation report. This report contained a comprehensive analysis of the tax system.  It contained a number of proposals and unfortunately one of its suggestions was that the reliefs mentioned above should be restricted. 

These proposals were not introduced last year; however it seems unlikely that any possibility of increasing tax revenue will be passed up in the forthcoming Budget/Finance Act.

So what were the specific proposals?

Capital acquisitions tax.  The Commission recommended that the taxable value of the assets be reduced by just 75% instead of 90% and that the reduction is to be capped at a maximum of €3,000,000. Any value in excess of the reduction would be taxed at the full 25% CAT rate. 

Capital gains tax.  If the Commission’s recommendation is implemented, that will be restricted in line with the CAT limit, so just the first €3,000,000 will be exempt and the rest subject to the full 25% CGT rate.

Using rough figures, today, the transfer of a family company worth €6,000,000 could be transferred from a parent to three children at a tax cost of €60,000. If the changes are implemented the tax cost would be around €810,000.     

The problem however is far worse than this as the money is the most likely source of this money effectively doubling the total hit on the business to c. €1.5m. Even for a healthy business this isn’t sustainable. The result is likely to be a major reduction in costs i.e. jobs.

Whilst the short term need to increase tax yield is understood it should be managed in a way that does not damage the businesses that will generate future taxes. Otherwise we all suffer. Hopefully sense will prevail in the December budget.

For advisors there is still a window of opportunity to help clients in this area. Transferring a business to the next generation can be achieved quickly, although proper planning for the future does need to be in place. If you haven’t already had this discussion with business clients now is the time to do so. 

A Watershed Moment

There is little doubt that the budget due in December will be of vital importance in terms of Irish economic development. Simply put if we get it right we can look forward to a prosperous future – get it wrong and we could suffer for decades to come.

Before we get too maudlin it is worth looking at the last great financial crisis in Irish history – the currency crisis and how it was viewed by one of Ireland’s leading economists. The following are  extracts from 12 defining moments in Irish history from the Sunday Business Post of December, 2006:

“The day credit liberated ordinary Irish people, David McWilliams
For many, January 31, 1993 is significant. It was the day the punt devalued, interest rates started to fall and the banks started to lend. It was the beginning of the process where the banks did what the credit unions had been doing for years - they started to lend to ordinary people. This greater and more democratic access to credit has done more to liberate millions of ordinary Irish people than any political move by any government in any decade since the foundation of the state. When you have credit, economic possibilities abound, social mobility becomes the norm and the aspirations and dreams of millions are achievable.

…. But quite apart from the economic impacts, the psychological effect of moving from a country where credit was rationed to a country where credit is freely available cannot be underestimated. The most liberating development in post-independenceIreland has been the emergence of credit. This credit has washed over us like a liberating, democratic soothing balm. It has eased the deep neurotic pain of being economically second rate and healed us of the great Irish affliction whereby we can only be financially successful when we are in New York, Sydney or Boston. 

Credit has harnessed our energies for the first time ever, at home. This development, more than anything else, changed Ireland and ushered in the new Ireland.January 31,1993, was the day old Ireland died."

Let us hope for all our sakes that December 7^th 2010 is the date Ireland is reborn.

The Problem with Reality

One of the greatest problems faced by Regulators of all sorts is how to deal with Reality. This isn’t as esoteric a discussion as it might sound. This month has already seen a clear example of how the Real World can upset the best laid plans.

The example is the “Unregulated Products” warning from the Financial Regulator. A sound idea in principle but does it work in the real world?

In the real world financial advisors deal with an array of Regulators and Ombudsmen all inputting to different parts of their business. A self-administered scheme is regulated by the Pensions Board but not by the Financial Regulator. Is this therefore an “unregulated product”?

YES – says the Financial Regulator – we don’t regulate it.

NO – says the Pensions Board – the Pension Board, the Pensions Ombudsman, the Department of Justice and the Revenue regulate it.

HELP – says the Financial Advisor trying to keep both happy.

Author: Aidan McLoughlin

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Disclaimer: 

• The opinions expressed are those of the individuals rather than Independent Trustee Company.
• Independent Trustee Company does not take responsibility for the accuracy of any content.
• The contents cannot be construed as advice.
• We would strongly suggest that any information provided should be discussed with your financial adviser before any action is taken.

How Much is Too Much?

We all know that Irish pension funds lost more value in 2008 than the pension funds of any other major economy. Belatedly the Pension Board has indicated that this is because Irish pension funds have too much invested in Irish equities. How do they know this? The question isn’t as stupid as it sounds.

Basic investment philosophy for at least 5 decades has suggested that returns above inflation are best achieved by investing in real assets such as equities. Various investment gurus have established that the risk inherent in equity investment can be significantly reduced by:

1.                  investing over a long period of time

2.                  investing regular amounts rather than lump sums and

3.                  using a diversified portfolio

All of these are available to Irish pension funds.

In addition, our population profile would suggest we have one of the youngest populations in Europe and (until very recently) a growing population.

Does that not mean therefore that we should have more invested in equities than any other country in Europe? If this is the case then events like 2008 will have a short term impact on fund values. However, overall the fund should continue to out-perform in the long term.

Unless, of course, you decide to get out of equities at the bottom of the market – thereby crystallising the loss and missing the bounce. Which you might do if your Regulator was saying you had too much in equities.

Author: Aidan McLoughlin

_________________________________________________________________________

Disclaimer: 

• The opinions expressed are those of the individuals rather than Independent Trustee Company.
• Independent Trustee Company does not take responsibility for the accuracy of any content.
• The contents cannot be construed as advice.
• We would strongly suggest that any information provided should be discussed with your financial adviser before any action is taken.