All You Need To Know About Lump Sums
A tax-free lump sum sounds like the type of windfall that appears in a lovely dream. But that dream can become a reality if you’ve prepared for your retirement. Indeed, many people do not realise that a pension not only gives you an income during your older years, but can also provide a cash injection just when you really need it. And yes, it is tax-free (up to a ceiling of €200,000).
Here is all you need to know about lump sum payments from your pension fund.
DEFINED BENEFIT (DB) PENSIONS
If you are a member of a DB scheme, your Retirement Lump Sum will be based on a defined amount (usually 3/80ths of final pensionable salary for each year of service). But withdrawing this lump sum will have an impact on the benefit payable afterwards, unless you have made sufficient Additional Voluntary Contributions (AVCs) to narrow that gap.
DEFINED CONTRIBUTION (DC) PENSIONS
The maximum tax-free lump sum that you can withdraw on retirement is 25% of the value of the fund (up to €200,000). But you will only be taxed at 20% on the next €300,000 withdrawn, with any further monies subject to a 48% levy (40% income tax and 8% USC).
Members of DC schemes must use the remaining balance in their pension fund to either purchase an annuity or invest in an Approved Retirement Fund (ARF). When you die, an annuity typically dies with you, whereas ARFs can be transferred to your spouse and/or children.
If you do not have enough in your pension to provide a guaranteed income for life of at least €12,700 per year, then you must invest at least €63,500 into an AMRF (Approved Minimum Retirement Fund). There are tighter restrictions on accessing your cash in an AMRF but withdrawals are not subjected to an “imputed distribution”. This is the name for the tax that Revenue charges against income from an ARF, based on you withdrawing either 4%, 5% or 6% of the value of the policy every year. Your financial adviser will explain this in more detail.
However, if you choose what’s known as a the “salary and service” route then your retirement lump sum will be a maximum 150% of final salary after 20 years of service where benefits are taken at normal retirement age.
The lump sum is reduced if you have fewer years of service and retire earlier than the normal retirement age. The balance of the fund MUST be used to buy an annuity; you cannot choose an ARF or AMRF if your lump sum is based on salary and service.
Non PAYE workers with private pensions, such as a Retirement Annuity Contract (RAC), or a Personal Retirement Savings Account (PRSA), also have a tax-free limit of 25% of the value of the fund for their Retirement Lump Sum, capped at €200,000.
You may claim benefits from a PRSA from the age of 60. Of course, the earlier you start taking money out of your PRSA, the more it will affect your pension pot going forward. A financial adviser will provide guidance here.
If you fancy quitting work as young as 50, you can access a Retirement Lump Sum from your pension pot if you’re a member of a DC scheme or a PRSA. For example, someone with a fund of €300,000 can draw down 25% (€75,000) tax free once they turn 50 and have left service. Public Sector workers and anyone in a DB pension scheme will have to check with their employer about early retirement options.
SPENDING YOUR LUMP SUM
This is the fun part. You might fancy travelling the world, paying off your mortgage, buying a fancy car or gifting some money to your adult children.
However, it is is always wise to seek expert advice when you are approaching the age where you can draw down a lump sum from your pension. The amount taken out will always have some implications for your financial future.