Retirement planning for company directors

Setting up a business is far from straightforward. As well as all the hard work and time it takes to build up and manage a profitable company, there is also a lot of risks for business owners.

Once the business starts turning a profit, company directors should be rewarded and start turning their attention to ensuring the profit accruing within the business begins to filter into personal wealth. Business owners reviewing their Company Pension funding often consider their pension fund as a standalone source of retirement income and can sometimes overlook the opportunity to utilise the features of a company pension plan to extract wealth tax-efficiently from their company into a personal asset.


Retirement planning will ensure you are taking full advantages of the tax reliefs available in Ireland business owners can ensure that years of hard work and struggle are rewarded with a robust exit and transfer plan.


Pension contributions are a good method of extracting funds from a business in a tax efficient manner. It can happen that business owners ignore pension contributions and concentrate instead on availing of “retirement relief”.

Managing Pension Wealth versus selling your business

So, what are the main differences, and which should you choose?

One of the most attractive, tax efficient ways for company directors to extract profits from the company and turn them into personal wealth, is to transfer these profits into a company pension.

The Capital Gains Tax (CGT) legislation provides an exemption from CGT where an individual is selling business assets at retirement.

The principal features of the relief are:

  • If aged 55 or over, there is a €750,000 exemption for gains on disposal of a farm, business or shares in a company.

  • The exemption reduces to €500,000 if aged 66 or over.

  • You don’t have to “retire” to avail of the relief.

  • You must have owned the assets for at least 10 years prior to the disposal. This works fine where you have a third party who is interested in acquiring your business.

  • If there isn’t a potential purchaser, you may be told you can avail of a company “buy back” of shares but relief is not automatic and must be comply with strict criteria set out by Revenue.

Using a Pension - summary of tax-relief

  • Up to 25% can be taken as a lump sum at retirement, the first €200,000 is tax free and the balance up to €500,000 is taxed at 20%.

  • The balance is transferred to an Approved Retirement Fund where you can draw down an income to fund your retirement subject to income tax.

  • You can access the pension from age 60 and you don’t have to ‘retire’.

  • If you have 10 years’ salaried service with the company, the company can fund for the maximum pension allowable (40/60ths of final salary).

  • The company can claim a corporation tax deduction on these funds.

how to manage pension wealth

PROFITS SUBJECT TO CORPORATION TAX

Salary is subject to Income tax up to 40% PRSI/USC up to 12% 


Car is subject to Benefit in Kind (BIK) up to 30% (calculation of BIK (i.e. taxable benefit) is 30% x Open Market Value of the car). 


Please note that the taxable benefit amount is subject to income tax, PRSI and USC.


Dividends: Income tax up to 40%. PRSI up to 4% and USC.


Sell Shares: subject to Capital Gains Tax (CGT) of 33%


Death: Assets are liable to Capital Acquisitions Tax (CAT) of 33%



TRANSFER PROFITS BEFORE TAX INTO A COMPANY PENSION PLAN

Where directors take profit from the company as salary there will be an immediate tax liability, however those who invest in a company pension plan enjoy benefits such as:

No benefit in kind on employer contributions

Immediate income tax relief on AVCs and employee contributions deducted from salary.

Corporation tax relief on employer contributions in the year the contribution is made.


In order to be eligible to take out a company pension plan the director must be set up as an employee of the company and be in receipt of Schedule E remuneration.


retirement planning for company directors

At retirement the director will be entitled to a retirement lump sum, some or all of which may be tax free. 


The balance of the fund can then be used to

Purchase an annuity which will provide a guaranteed pension income for life,

Invest into an Approved Retirement Fund (ARF)

Take as taxed cash, subject to certain restrictions


Pension income in retirement and withdrawals from ARFs are subject to income tax, Universal Social Charge (USC) and PRSI (if applicable) and any other taxes or government levies due at that time. Income tax relief is not guaranteed. 

CAPITAL GROWTH - TAX FREE

Tax Relief for the Company

Retirement lump sum and 


Income for life (taxed)or ARF (income taken is taxed)


or Taxed cash


Contributions made by the company into an Executive Pension can usually be offset against corporation tax, as these payments are deemed to be a legitimate business expense (subject to revenue limits).

Tax relief for the director

If accrued profits built up in the company are taken out as salary, the director will have an immediate Income Tax, USC and PRSI liability. If the proceeds are then made as contributions into a pension scheme, the contributions will receive tax relief and will be able to grow tax-free, until such a time when you decide to draw on this benefit.

There is also no ‘benefit in kind’ charged on employer contributions.

What Size pension fund can I have?

Individuals have a maximum lifetime limit of €2 million to which they can fund their pension to, once they have the required salary and years’ service. This amount can be funded by making a regular annual premium. The company can offset the full amount of the regular annual premium, assuming these are employer contributions.

Revenue also allows special contributions (single premiums) to be made into an executive pension in order for the individual to fund for the €2 million threshold. If the company has built up excess profits, and the special contribution is more than the regular premium, they can spread forward the relief over a number of trading years, potentially reducing the corporation tax in each of those years as well.

This allows companies to fund for ‘back service’, for those employees who had not received pension payments before. A scenario where this may occur is perhaps where the company was not previously in a financial position to make such contributions.

Example: Mary a company director maxing out pension contributions

Mary is 55 and has run her own business for 10 years and is currently drawing a salary of €100,000. Mary is hoping to retire in 10 years’ time (age 65). Her company is currently contributing €25,000 into an executive pension which has an overall value of €200,000. The company is performing well and they have profits of €300,000 and this is expected to grow in the future. Mary wants to fund for the €2 million threshold at her retirement age of 65, assuming a growth rate of 4.5%. 


Option 1: The company could increase the annual regular premium to €113,500 per annum. 


Option 2: The company could make a special contribution of €200,000 and then make annual contributions to €94,800


                    Special Contribution               Annual Regular Contribution

Option 1:     Nil                                                €113,500


Option 2:    €200,000                                             €94,800


If Mary decides to go with option 1, the company can offset the €113,500 annual regular premium contribution in the current trading year, reducing the corporation tax this trading year. This can be done every year the regular premium is paid. 


If Mary decides to go with option 2, the company could offset the €94,800 annual regular premium in the current trading year, reducing the corporation tax this trading year. This can be done every year the regular premium is paid. 


As well as this, as the ‘one off’ single premium special contribution is greater than the regular premium, the company can spread forward the relief for this contributions over a number of trading years, potentially reducing the corporation tax liability in future years.

Can mary’s spouse John have a pension?

It would is not uncommon for many directors of small businesses to also have their spouses working in the business. These would range from active directors to part-time workers. 


The company can also put in place a spouse’s pension. With a part-time worker, it makes sense to fund for the max pension of 2/3rds final salary. The spouse needs to have a declared earned income within the business in order to qualify for pension funding.

Example: Mary’s husband John (55) is paid a salary of €20,000 per annum.

An executive pension could be put in place which attempts to fund for 66.6% of final salary (escalating @ 1.5% p.a. which would equate to €29,000 at age 65). We could also include a 100% spouses’ pension as a requirement. 


A pension fund of €500,000 would be required for this pension. 


Assuming John has no other retained pension benefits, the company could make contributions of €43K per annum which could be offset against the corporation tax liability. It is worth noting that Revenue will want to ensure that a spouse is actually working in the business and is being paid a reasonable rate of pay for the work they are carrying out.

Funding for a Maximum Lump Sum

A director can also fund for a maximum tax-free lump sum of 150% of salary once they have more than 20 years’ service. If a director has a salary of €100,000, they can fund for a pension pot of €150,000 (150% of salary). 


This will then be able to withdrawn as a tax-free lump sum. The pension can be funded from company contributions which as previously explained will in turn reduce down the corporate tax liability.

Retirement Relief

Retirement Relief is also worth mentioning when speaking about extracting profit from a business as this might also give rise to crucial tax relief benefits when the day comes that you wish to dispose of the business and extract the value built up in it. 

This relief applies where a person aged 55 or more disposes of a farm or business. 


This must be a qualifying asset. 


There are two types of relief available. 

If you dispose of your business or farm to your child, then the gain is exempt. There is no limit on the value that may be passed to your child, however, there is a lifetime limit of €3 million where the disponer is aged 66 or over.


If you dispose of your business or farm to any other person, the gain is exempt if the proceeds do not exceed €750,000. There is a lifetime limit of €500,000 if the disponer is aged 66 or over. 

Retirement relief is subject to a “bona-fide commercial reasons” anti-avoidance test. This should be discussed as part of the overall retirement planning process and should form part of your estate planning.

Entrepreneur Relief

This is a relief which was introduced to reduce the rate of CGT applicable when entrepreneurs sell their business. This is to encourage business development and to reward those who take risks in starting up a new venture. 


The relief reduces the rate of CGT to 10% (reduced from a normal rate of 33%). This relief only applies to the first €1 million of gains. 


There are a number of conditions that need to be met in order to qualify for this relief and it is important to consider the business structure to ensure that nothing precludes the eligibility of such relief. 


This can be a complicated area and tax advice should be sought before any major corporate restructures, incorporations or introspective transfers take place.

Warnings

  • The value of your investment may go down as well as up.
  • These figures are estimates only. 
  • They are not a reliable guide to the future performance of your investment.
  • If you invest in this product you will not have access to your money until age 60 and/or you retire.

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