Time to reform the SFT on pension funds

The Standard Fund Threshold set at €2m in 2014 needs to increase to account for inflation, life expectancy, annuity costs and demographics. In response to a public consultation by the Department of Finance, KPMG highlights that the current €2 million upper limit on a pension fund above which a tax charge of 40% applies should be raised to as much as €3.475 million simply to keep up with the current cost of living.

A failure now to adjust the assumptions underlying the calculation of the Standard Fund Threshold may leave pensioners short-funded at a vulnerable time in their lives.

The Standard Fund Threshold (SFT)

In December 2023, the Minister for Finance announced a review of the SFT. In the launch document, the Minister noted that the examination will consider the role of the SFT in the current pension landscape, the current calibration of the SFT and its potential impacts on recruitment and retention (see Consultation document on the Standard Fund Threshold PDF, 590KB).

The SFT was introduced in December 2005 to place a lifetime limit on the total capital value of pension benefits that an individual could draw from tax relieved pension products. Where an individual breaches the lifetime cap at retirement, the excess is subject to penal taxation at an effective income tax rate of up to 68.8% - of which 40% is incurred upfront, with the remaining balance collected on drawdown.

The SFT was initially set at a level of €5 million, with provision made for it to be indexed at regular intervals thereafter in line with an earnings factor. While it was indexed up to a highwater mark of €5.4 million, the financial crisis intervened and the SFT was reduced to €2.3 million in 2010 and to €2 million in 2014.

KPMG submission

In response to the Department of Finance's public consultation, we made the following points:

Threshold and inflation

The €2m threshold has remained unchanged for a decade. It needs to be rebased to take account of economic, social and demographic changes that have occurred. Going forward, it will be important that the SFT is rebased on a regular basis.

Inflation has greatly eroded the real value of the SFT. Over the period between 2014 and 2023 Irish wage inflation was 34%. This alone merits an increase in the SFT to €2.68 million.

Changes over the last decade

There are a number of other significant factors that cannot be ignored:

As prevailing long term interest rates have increased significantly since 2014, it now costs more to purchase a pension annuity.
Average life expectancy in Ireland has increased over the past decade. This means that an individual’s pension pot typically needs to fund pensions for 2 extra years.
It has been noted by the ESRI that future cohorts of retirees are likely to face substantially lower rates of home-ownership than recent retirees. Many will need to fund mortgages (or rent) into retirement.

Our recommendations

filter_1

Increase the SFT

To address these issues and the impact of wage inflation, the SFT should be increased to €3.475m. Of this, up to €500k (up from €200k) should be available to be taken as a tax-free lump sum to take account of inflation and help pensioners to meet their housing commitments on retirement.

filter_2

Re-assessment of pension contribution rules

An increase of the SFT will also necessitate a re-assessment of the pension contribution rules for individuals. Currently, the pension contribution limits for individuals are based on a percentage of pensionable earnings of up to €115k.

An increase in line with the SFT would see the limit increase from €115k to €200k. This would still fall well short of the €275k limit that applied as far back as 2008.

The earnings cap of €115k should be rebased and indexed annually to allow individuals to build up sufficient funds aligned with an increased SFT to give them access to an appropriate and fair level of retirement income.

filter_3

Whole of life approach

As it stands, the annual pension contribution limit for individuals operates on a use it or lose it basis. Individuals are not permitted to carry forward unused pension contribution capacity from year to year.

Given the diverse working patterns and financial commitments of individuals over their working lives, we advocate for the adoption of a “whole of life approach” to allow individuals to carry-forward unused pension contribution limits.

filter_4

Equalise treatment of private- and public-sector employees

There is also a need to equalise the treatment of private sector taxpayers with public sector employees. Public sector employees are afforded an opportunity to mitigate the 40% liability by taking a refund of pension contributions and/or pay the tax in instalments over 20 years.

All taxpayers should have access to the favourable treatment currently only open to public sector taxpayers.

Examination of the Standard Fund Threshold

For more, download our full submission

Get in touch

If you have any queries regarding pensions and pension thresholds, please contact Colm Rogers or Tom Woods of our Tax team. We look forward to hearing from you.