Tax Relief: How it Works

We hear it all the time in Ireland: “You should be putting money into a pension plan, the tax relief is fantastic!” and so on.

So, what’s all that about, is it just these financial advisors trying to relieve us of our precious, hard-earned money so they can make zillions in commissions on the sweat of our brow?

Not at all!

Pensions seem to generate a lot of queries and questions so I hope to start a Frequently Asked Questions (FAQ) section to address some typical queries in the near future.

But for now, I would like to offer a straightforward explanation of how tax relief works.

There are two parts to it in Ireland.

Firstly:
say we are earning sufficient income, from either employment or from self-employment, to actually pay income tax. The tax we pay will be on our payslip or accounts.

Therefore the taxman (or woman!) is taking a chunk of everything we earn.

So we take home less than we actually earn. Sometimes an awful lot less! Most of us accept this without even thinking about it! Ok!

Say we’re on the standard rate of income tax. That’s 20% in Ireland, or 20c income tax in every €1 we earn. We then take home the 80c. There are other issues here as well, but I will touch on them another time.

Say now we decide to put some money into a pension plan. For argument’s sake €80 per month.

That means the taxman puts the €20 he took off us back into the pension plan as well.

It’s the tax relief.

We won’t get this from savings in banks, building societies, credit unions, etc. and that’s another reason it’s so much better than simple savings.

So, all of a sudden the €80 we saved for our retirement has grown back to €100, with the help of tax relief!

We’ve just earned a fantastic return on our €80 regardless of what the investment markets are doing!

Now, say we’re paying tax at the high rate, 41% in Ireland. In this case the taxman puts €55.59 of tax we have paid back into our pension plan!

Now, what do you think of that? It’s an enormous recovery of money otherwise just gone!

Secondly:
investments in pension funds roll up free of taxes in the fund. In other words, no DIRT tax, capital gains tax, exit taxes, etc, which we would pay if we just saved your money in banks, building societies, credit unions, etc.

Over time, this makes a very big difference & is another major advantage. Think about just the DIRT tax we pay on any savings we may have now!

So, we should avail of as much tax relief as we can for when we need it most – otherwise, pay the tax & be happy!!

In my opinion there is no case for complaints if we are living hand to mouth when we have to go on pension and had not availed of the incentives when we could and should! – we always are where we are as a result of the decisions we have taken! And no decision is still a decision!

Just three important points to bear in mind about tax relief:

1. The taxman doesn’t run a charity, never has. He will still be around when we retire. Pension income in retirement is assessable for income tax. Because our income when we go on pension usually comes crashing down, we normally pay far less tax and give very little of the advantage of tax relief back to the taxman. On balance it’s a huge gain.

2. There are Revenue limits on tax relief. We also get tax relief only to the extent that we are paying taxes. It doesn’t automatically follow that if we are paying some or even a lot of tax at the high rate, all our tax relief is at the high rate. This is very important.

3. There are moves afoot in Ireland to put in a uniform rate of relief for taxpayers on pension contributions in the future, regardless of tax bracket. This will be a very positive thing for many people, and may reduce the advantages for others.

So, unless we are very familiar with taxation matters, it’s important to take professional advice.

On that point, as Red Adair, the famous American wildcat oil well fire fighter said: “If you think hiring a professional is expensive, try hiring an amateur!!” Again, in my view, this is something we seriously need to consider in Ireland!

A last important point: in Ireland neither interest earned on investments and savings, nor rental income qualify as relevant earnings for tax relief purposes.

Be delighted to hear of experiences or queries you might have on tax relief and pensions, thanks.

Related posts:

1. Tax relief – how much for you?
2. The Goose, The Pensioner and Food
3. Making Pension Contributions? Tax Relief Claim Deadlines
4. Perhaps Don’t Bother Any More
5. Tax on Interest (DIRT)