You’ll hear strong opinions in both directions! Some people insist on waiting until the mandatory age of 65, 70 or 75, depending on the scheme.
Others argue for an early withdrawal. Either approach may make sense depending on your situation!
That’s why I’m sharing the following with you this week:
- While it could make sense to get income from pensions
- While it could make sense not to receive income from pensions
- A few nuances that can help you optimize your own retirement income planning
The correct approach to whether or not to withdraw pension income usually depends on:
- the income you already have
- the tax brackets available to you and your partner in your household
- the lifestyle and spending habits you want to have 🙂
Below I outline and provide some details on 3 possible household setups and scenarios.
These are high level and I haven’t gone into the detailed level for now, but the principles will hopefully be of value to your own scenario.
They show how your income mix determines your tax results and your long-term flexibility.
You are each 55 years old.
You are already retired 🙂
Each partner has €800,000 in pension and jointly €500,000 in savings or investments.
Your living costs are approximately €70,000 per year.
And note that we assume that their pensions are in PRSAs (Personal Retirement Savings Accounts) or Buy Out Bonds (BOBs) or Deferred Vocational Schemes, and that they are required to start taking income from them at age 70 (for BOBs) or 75 (as is the case with PRSAs). If you have a DB (Defined Benefit) pension, you will usually receive your income on a fixed date, whether you want it or not!
Scenario A:
Rental income covers most of lifestyle expenses 🙂
Síle and Marvin are in a good place here (fictional characters!):
- Rental income from investment properties: €60,000 gross
- Future combined state pensions: c€30,000 gross
- PRSAs of €800,000 each
- Target expenditure: €70,000 per year
They have strong rental incomes and large pensions of €800,000 each or €1.6 million in total, and have made the brave decision to pack the job in, get it over with!
The most important question they can ask themselves is whether they should sign each pension income before they are required to do so at age 70 or 75, etc.
Age 55 to 66
Tax on €60,000 rental income
I assume that the income is assessed jointly and in principle € 30,000 each is split.
Standard rate (20%) available band is €83,000.
Income tax of 20 percent
• 60,000 at 20 percent gives 12,000
• Less married credit 4000
• Income tax c€8000
USC
• Total c€ 1,333
CHEST
• 60,000 at 4 percent = c€ 2,400
Total tax c€11,733.
Net rental income here of c€ 46,000.
They spend $70,000 a year on all kinds of things, so $24,000 could come from deposits or investments to cover the shortfall.
They don’t need it no pension income yet, and their pension funds can remain fully invested for the time being!
Age 66 with state pensions
Rental income €60,000
State pensions €30,000
Total €90,000
Standard band €53,000, and raised by lower incomes up to €35,000.
A lower income is around €45,000, so the band becomes €88,000.
Total income tax here is therefore c€ 14,000.
USC on an income of €90,000 is €3,240 and there is no PRSI once the state pension starts.
Total tax c€17,150
Net income c€72,850
Their expenses are now fully covered by rental income and state pensions.
They still don’t need ARF income unless they really want or need it for donations or other purposes!
Future ARF withdrawals will likely be surplus, all things being equal.
Why this approach can be useful
• Before crystallizing, they are not forced to take taxable retirement income in the form of “imputed benefits.”
• Rental income and later state pension coverage are needed to lead a comfortable and enjoyable lifestyle
• Pensions remain invested for longer and hopefully grow upwards completely tax-free – and payable as tax-free proceeds upon the death of either
• ARF withdraws stay in optional and strategic
You can ask yourself
• Do you actually need pension income in your fifties?
• Or should you let the pension grow?
Scenario B:
One salary. Big pensions. One partner without income
Partner A (Grainne) earns €50,000.
Partner B (Timmy) has no income.
Both have around €800,000 in pensions and €500,000 in savings.
The spending goal is €70,000.
The unused bond of the non-earning spouse is the key question.
Baseline without pension withdrawals
Income tax on Grainne’s €50,000
• Everything taxed at 20% = €10,000
• Less married and PAYE credits €6,000
• €4,000 Income tax on that income.
Plus USC of €1,305 and PRSI c €2,000
Net income approximately € 44,950.
Using the income margin of the non-earning partner (Timmy).
Let’s say that Timmy voluntarily withdraws € 25,000 from his pension pot.
The total income will be €75,000.
Standard tire
• Basic €53,000
• Raised by lower income € 25,000
• Total income bracket €78,000
75000 taxed at 20%
• Gross € 15,000
• Min combined credits €8,000
• Total income tax approximately €7,000
And USC c€ 2,040
Net income approximately €65,960.
The additional net income from the voluntary withdrawal of €25,000 amounts to c€21,000.
About €4,000 tax on that drawing, so an effective tax of about 16 percent.
Why this helps?
• Income increases close to the target without sacrificing savings, and does so in an efficient manner
• The non-earning spousal bond and PAYE credit are finally being used
• Savings remain intact
• Future ARF size gradually decreases (which can balance lifetime tax rates)
• Later tax peaks are avoided when two state pensions on top of the forced ARF drawdowns at that point in the future
A simple question to think about in these types of scenarios:
• Is one partner bond standing still?
If so, modest pension cuts of 20 percent (less credits/allowances) could be very efficient.
Scenario C
No salary. No rental income. All income from pension or savings
Both 55 years old.
Each has €800,000 in pensions and €500,000 in savings.
Spend €70,000.
Based on pensions in the 20% bandwidth
For example, each partner draws €35,000.
Total pension income €70,000 gross.
Standard tire
• Basic €53,000
• Raised by lower income € 35,000
• Total €88,000 standard band, so all income here falls within the 20% band.
Income tax
• €14,000 gross income tax
• Fewer credits €8,000
• Net income tax c€6,000
Plus USC of approximately €1,650
This results in a net income of €62,350, with an effective total tax rate of just 11% – thank you very much! A small addition from savings (or more pension withdrawal) therefore covers expenses.
Why this makes sense
• All pension income taxed at 20% instead of 40%
• Combined rate approximately 11% on €70,000
• Savings remain available for shortages and one-off costs
• Low withdrawal rate on the ARF, so that the ARF decreases slowly, alleviating future forced withdrawals and income needs
• You’ll avoid a sharp income tax problem in your late 60s!
The problem with waiting until 66
• Pension pots can grow considerably, which is of course a good thing, but
• Required withdrawals of, for example, 5% can cause income to exceed €100,000 plus
• Two state pensions add more than €30,000
• A significant portion of income is taxed at 40 percent
Withdraw part of your pension income early
• keep yourself in the lower band and make use of potentially available allowances and credits
• reduces future forced drawdowns
• spreads the burden more evenly over life
What the 3 scenarios show us:
You don’t need a perfect formula, and despite the analysis above, overanalyzing all of this can be self-defeating!
Rules, rates and your needs will change over time. So what I encourage is that you don’t just withdraw retirement income when you think it’s meant to be for you, but instead do some analysis to see if there are any clear opportunities or threats to your tax efficiency and future needs.
It’s important to understand how your sources of income interact with the Irish tax system!
Key points:
- Strong rental and state pension income can justify postponing pension withdrawal in many cases
- A non-earning partner with a pension pot could consider efficiently withdrawing income within the 20% bandwidth
- Couples without a salary or rental income often benefit from structured retirement income instead of extremes
- The standard rate band and PAYE credits are powerful planning tools
- State pensions plus the additional benefit withdrawals allocated by the ARF can together create a 40 percent tax problem if you have not planned for this
- Early, modest retirement withdrawals can reduce large forced ARF withdrawals in the 1960s and 1970s and beyond!
- The right mix finances your life and reduces tax waste
All of the above scenarios are ‘nice to have’ aspects to navigate through, there’s no doubt about that. But smart navigation can be the difference between a retirement full of opportunity and choice, and a retirement with far fewer of these desirable aspects!
I hope it helps.
Paddy Delaney
#Generate #taxefficient #income #PRSA #ARF #50s