According to the Organisation for Economic Co-operation and Development (OECD), the average retirement age differs from country to country. 

In Japan and Korea, people retire around 70, while in countries such as Austria, France, and Luxembourg, people often retire around the age of 60. In Ireland, the average retirement age is 65 – and rising! 

Everyone knows retirement is important to plan for, especially if you’re self-employed or a business owner, but it is too easy to put on the long finger. In this guide, we’ll explain everything you need to know about pensions for small business owners and self-employed people in Ireland, how the tax reliefs available on pension contributions work, and the top 5 reasons to get into the habit of contributing to your pension on a monthly or annual basis.

Everything You Need to Know About Self-Employed Pensions in Ireland

Planning for retirement has never been as important because people are living longer. In fact, by 2046, Ireland is expected to have over 1.4 million people aged over 65. The longer you live, the more money you’ll need to save up for your retirement. 

Self-employed business owners in Ireland are entitled to a state pension, providing you’ve met the necessary requirements and providing you have made enough PRSI contributions by the time you reach retirement age. 

The state pension won’t provide you enough money to comfortably live on, which is why it’s important to think about setting up your own private pension, and to start setting aside funds on a periodic basis – in the short term, you will get tax relief on your pension contributions, and in the long term you will accumulate a fund so that you can have the quality of life you would like in retirement. There are several different types of pension plans, depending on your business structure i.e. sole trader, partnership or limited company. As a sole trader, you can set up a: 

Personal Retirement Savings Accounts (PRSAs) 

Retirement Annuity Contracts (RACs) 

If you are a proprietary director with your own limited company you can set up an occupational pension scheme (i.e. a company pension scheme) or a small self administered pension (SSAP) – more about these later. 

Whatever the pension type, the logic is all the same. Your pension is a long-term savings account, contributions to which are made from your GROSS income i.e. without suffering a tax charge (subject to certain thresholds and rules) and, in general, you cannot access the funds until your retirement age.

When Should I Start a Pension?

The short answer is now! The sooner you can start saving funds for your pension the better. There are two reasons for that:

1. The first being that the sooner you get into the habit of saving money the easier it’ll become.

2. The second being that the sooner you start saving, the more money you’ll have and the less tax you will pay over your working life.

For example, if you start saving at the age of 22 putting aside €5,000 every year into a pension with a return on investment of 6%, you would have almost twice as much saved over the long term than if you started 10 years later at age 32.

In this example, the 22-year-old you, who started saving 10 years younger, would have about €500,000 more when you retire.

Why Do I Need a Private Pension?

But saving your hard-earned cash can be difficult without a clear picture of why. Why do you need a pension? Those who qualify for a state pension might wonder why they can’t just live off that.

As of 2020, you qualify for a state pension if you’re 66 or older and have paid enough Class A, E, F, G, H, N, or S social insurance contributions (PRSI).

State pensions vary, depending on age and contributions, however, the maximum state pension is €248.40 per week which works out as a little under €13,000 per year (before tax is paid).

This can help with the basic costs of living for some, but you might find that this isn’t enough to live off. That’s why it’s vital for the self-employed to plan for their pensions.

Contributions to private pensions qualify for tax relief in Ireland. This means that the money you contribute to your pension won’t be taxed, ensuring you can put more money into your pension account rather into the revenue’s account. Further, any income earned or growth on your investments within your pension is earned completely tax free and rolls up in your pension pot.

How Does Tax Relief on Pensions for Sole Traders in Ireland Work?

Let’s take an example. You are a sole trader in Ireland, aged 44, and you have profits of €100,000 (i.e. the amount left over after you have taken away all tax allowable business expenses from your revenue). Ordinarily, at this level of income, you would be subject to the higher or marginal rate of tax, which, when PRSI and USC is taken into account, is as high as 55% – over half of your income!

So, for simplicity’s sake, let’s estimate your tax bill at €55,000 (it would generally be lower than this, due to a portion of your income being at the standard rate of tax, and due to you being able to claim certain tax credits).

By mid-November of the current year, you will have to pay your tax bill of €55,000 PLUS your preliminary tax (see more about preliminary tax here) of another €55,000 to the revenue i.e. total payment of €110,000.

Now, let’s say that your accountant advised you to make the maximum tax-relieved pension contribution so as to increase your pension reserves while reducing your tax bill. In this case, the maximum tax relieved contribution works out as €25,000 (being 25% of your income for ages 40 – 49). You make the payment into your pension before end of October of the current year.

Your tax bill is now reduced from €55,000 to €41,250 i.e. a tax saving of €13,750. This is because the €25,000 is paid from your profits before tax, and your remaining profits of €75,000 is what is now subject to tax. Further, your preliminary tax matches your current year tax liability, and as a result you have a total payment to the revenue to make amounting to €82,500.

Taking the revenue payment plus your pension payment, the combined payment or cash outflow amounts to €107,500.

So, in short, you can pay €110,000 all to the revenue OR you can pay €107,500 split into €82,500 to the revenue and €25,000 into your own long-term pensions savings account. Cashflow-wise, the pension contribution makes a whole lot of sense.

Don’t I end up just paying the tax at retirement, so what’s the point?

At the point of retirement, you can drawdown 25% of your total pension pot tax free (subject to a maximum tax free lump sum of €200,000, with the next €300,000 at the standard rate of tax (i.e. 20%)) – so if you have managed to set aside €800,000 over the course of your working life, you will get a €200,000 tax free lump sum from your pension at the point of retirement, and the remaining €600,000 can be drawn down by you over your retirement – this portion is subject to income tax as and when you draw it down. However, in general, you will be subject to the standard rate of income tax (while you made tax savings over your lifetime at the higher rate), and further there are other tax advantages available for 65+ year olds in Ireland, meaning that your income tax on your pension earnings will likely be much lower than the 20% standard rate, and might even be nil depending on circumstances.

As a sole trader, how much can I contribute to my pension each year?

The amount of tax you are relieved of depends on your age and the actual amount of tax you save will depend on whether you are paying tax at the higher rate or at the standard rate.

Under 30’s can make an annual maximum tax-relieved pension contribution of up to 15% of their income. 30 to 39-year-olds can make an annual maximum tax-relieved pension contribution of up to 20% of their income. 40 to 49-year-olds can make an annual maximum tax-relieved pension contribution of up to 25%. This increases to 30% for 50 to 54-year-olds, and increases to 35% for 55 to 59-year-olds, and then increases to a maximum of 40% for those aged 60 and over.

The above percentages can be applied to a maximum income of €115,000. So, if you have trading profits of €140,000, for example, and you are age 38, the maximum tax relieved pension contribution you can make is 20% of €115,000 (not €140,000).

Let’s take another example, a 28-year-old earning €60,000 per year, would have a maximum tax relieved pension contribution of €9,000 (15% of €60,000 = €9,000). If the 28-year-old made a €9,000 contribution, this portion of their income would be exempt from income tax meaning they’d save up to 55% of €9,000 in tax.

You may contribute more to your pension than the thresholds outlined above, however only the amount falling within the thresholds will receive tax relief in the current year.

What's the Difference Between a Company Pension Scheme and a Personal Pension Scheme?

A company pension scheme is set up for you by your company, and is suitable for proprietary directors (i.e. a business owner who operates through a private limited company).

The main difference between a company pension scheme and a personal pension scheme is that a company pension allows both employee contributions and, importantly, employer contributions.
Employee contributions are amounts that you would contribute yourself out of your PAYE salary from your company, which are subject to the same amount and age limits outlined in an earlier section.
Employer contributions are amounts that are paid by your company directly to your pension pot.

This type of contribution is not subject to the same amount and age limits as apply to employee contributions. This means that you’re able to make larger tax-free contributions to your pension pot. For proprietary directors, this is an important tax planning and cash extraction tool because you can make pension contributions that are not restricted by the age thresholds.

How Does Tax Relief on Pensions for Proprietary Directors in Ireland Work?

As a proprietary director, you operate your business through a private limited company. A key benefit of operating your business as a private limited company rather than as a sole trader is the ability to make larger tax-relieved pension contributions. 

This is because you may elect to make an employer contribution from your company to your pension pot, whereas as a sole trader you do not have this option. An employer contribution is not restricted by age, and in general, you will find that the contribution amount will be restricted more so by your available funds rather than the limits imposed by revenue rules that apply to employer contributions. However, it is important to check with your accountant or financial advisor to ensure you do not fall foul of the max-funding rules in place. 

An employer pension contribution can be made completely tax-free. It is an allowable deduction in your company accounts and in computing your profits, which are subject to corporation tax. Further, there is no employer PRSI on an employer contribution. You will not pay any income tax or PAYE tax on the employer contribution

Taking an example, if you have €100,000 of profits in your private limited company, you might decide to pay yourself a salary at the standard rate band level (i.e. €35,300) so that you only pay standard rate income tax (20%), and you might then decide to contribute the balance of your profits, €64,700, into your pension. You will not pay any tax on the pension contribution, and your company will now show Nil profits and will therefore not pay any corporation tax. 

You can now use your funds in your pension pot to invest and any growth in your investments will roll up completely tax-free in your pension.

What types of investments can I make with my pension?

It will all come down to the type of pension you have, and who you have taken your pension out with.

If you set up a pension with a life assurance company (e.g. Standard Life or Aviva etc.), you will generally have access to their wide range of mixed asset investment funds – matching the risk level of the fund with your risk appetite.

If you prefer to have more control over your pension, a small self administered pension is likely the best choice for you – with an SSAP, you have complete control over your investment choices and can even make direct investment in equities or in property. Further, you can borrow with your SSAP – meaning you can leverage your pension contributions to accelerate your investment growth.

For this reason, and due to the level of tax outside of a pension, there is a trend in Ireland toward small self-administered pensions being used to buy residential buy-to-let properties.

Taking the example in the previous section, you could use the €64,700 contributed to your pension to raise borrowings of a further €64,700, and buy a rental property with a yield of 10% – the rental income on the rental property is earned in your pension completely tax-free, and any appreciation in the value of the property itself is also earned tax-free. Read more about property investment through your pension here.

Is there an overall limit on the size of the pension pot that I can accumulate?

Yes. The maximum pension pot you can amass is €2m. If your pension pot exceeds €2m in valuation, you will be subject to punitive excess taxes. Where you are nearing the €2m pension level, it is important to monitor it, as even in the absence of additional contributions to your pension, the investment values in your pension may increase over time – in which scenario you run the risk of exceeding the €2m limit, and triggering excess tax, without realizing or intending to do so.

When Can You Access Your Pension Funds?

It can vary when you’re able to access personal and company pension funds, depending on the contractual agreement.

With most PRSAs, you can start to draw on the funds between age 60 and 75. Some may allow you to take the funds out earlier, such as when you turn 50 or if you have a serious illness that prevents you from working. On retirement, a PRSA allows you to take up to 25% of the fund as a tax-free lump sum.

With most RACs, you can also start to draw on the funds between age 60 and 75. RACs also allow you to take out funds due to ill health. However, you don’t need to retire to benefit from the withdrawal of these funds.

Upon retirement, those with a RAC can take up to 25% of their retirement fund as a tax-free lump sum. Legal requirements may differ on your pension scheme, so do make sure you verify with the provider when you can access the funds.

Most occupational or company pension schemes will allow you to start drawing the funds from age 50, provided you actually retire, or from age 60, even if you have not retired. At the point of drawdown, you can take up to 25% of your retirement fund tax free, subject to a maximum tax free lump sum of €200,000, with the next €300,000 at the standard rate of tax (i.e. 20%).

How Do I Set up a Pension?

Whether you’re a self-employed and want to start saving for retirement or you’re a small business owner looking to set up pension schemes for your employees, the first step in setting up a pension is understanding all your options.

So, talk to financial advisors about your pension needs. Your financial advisor will be able to walk you through the different pension schemes and investment options. They’ll also be able to help you choose the right one for you and your business. Once you’ve found the right pension plan, you can then find the right life assurance or Investment Company for your money, or you might choose to go the self-invested pension route.

Pensions can be a very important tax-planning and cash extraction tool for small business owners in Ireland, so get in touch with our team to discuss your self-employed pension needs. Whether you are looking to start your first pension, or whether you are looking to minimize your tax rate while moving towards retirement, we will be able to help you find the right pension scheme for you and develop the optimal tax-efficient retirement plan.