Nineteen months of unused tax-free cash
Fiona, 63, is a self-employed consultant. She has a buy-out bond of €620,000 from a former employer's scheme and €330,000 in an executive pension with her own company - €950,000 in total. In 2014 she took €60,000 of tax-free cash when she left the earlier employer. She now wants to stop working, take as much tax-free cash as she can, and put the balance into an Approved Retirement Fund. She has asked you to process everything before 30 November so she can 'use this year's tax band'. She has no other income in the current year, wants €25,000 a year net from the ARF, and expects to be a higher-rate taxpayer when she draws. She has also asked whether she should simply leave everything invested until she is 67.
1. Calculate the maximum tax-free lump sum Fiona can take and the amount that must go to the ARF.
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Step 1 – The 25% rule. On a fund of €950,000, 25% is €237,500. That is the ceiling on a scheme-by-scheme basis.
Step 2 – The lifetime cap overrides it. The tax-free lump sum is subject to a lifetime limit of €200,000 across all arrangements. Fiona has already used €60,000 in 2014. Her remaining capacity is:
€200,000 − €60,000 = €140,000
Step 3 – Allocate.
- Tax-free lump sum: €140,000 (not €237,500)
- Balance to ARF: €950,000 − €140,000 = €810,000
The €97,500 of the '25%' that she cannot take tax-free does not vanish as a benefit; it simply transfers into the ARF and will be taxed as income when drawn. Taking it as a taxable encashment instead would be possible but is almost never advisable at her marginal rate.
Step 4 – Check the Standard Fund Threshold. At €950,000 she is well below the €2m threshold, so no charge arises on drawing benefits. Watch it if she continues contributing to the company arrangement between now and 67.
Assumptions to state in the file: the €200,000 figure is the lifetime limit applicable to her and no other scheme has used capacity; the buy-out bond and executive pension can both vest on the same date.
2. Explain the ARF's tax treatment in year one and test her belief that a November vesting 'uses this year's tax band'.
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How the ARF is taxed. The ARF is not subject to exit tax. Its value grows free of tax on income and gains, and every euro withdrawn is taxed as income under PAYE at her marginal rate, plus USC and, where applicable, self-employed PRSI. There is no tax-free element in the ARF itself.
The imputed distribution. Where an ARF owner is 60 or over, Revenue requires a minimum annual withdrawal of 4% of the ARF's value up to €2m (5% on the excess). Withdrawals actually taken during the year count towards it; if she takes less, the shortfall is deemed to be withdrawn and taxed anyway. On €810,000 the imputed figure is roughly €32,400: taking nothing is not an option, and leaving the money to roll up untouched while she has no other income is a wasted opportunity.
Her 'use this year's tax band' instinct is half right. With no other income, the first €44,000 (single standard rate band) of ARF income is taxed at 20% rather than 40%. Drawing up to that band this year and next is genuinely efficient. But two corrections:
- The imputed distribution is measured against the ARF's value at the date it is first funded and the withdrawals made in that year; a late-November vesting does not give her a free year. The decision must be modelled on the actual vesting date, not on a guess.
- Taking €44,000 a year would fund her €25,000 net requirement comfortably; drawing more than needed purely for tax reasons permanently depletes a fund that still has to last 30 years.
3. She wants to vest now at 63 rather than wait to 67. What non-tax factors must you put to her, and what must be in your advice file?
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Factors against vesting now:
- Income is no longer guaranteed. An ARF is a personally-owned investment; if markets fall early while she draws €25,000 a year, the loss is permanent. Sequence-of-returns risk at 63 with a 30-year horizon is significant.
- An annuity purchased now is priced on current yields and her age; waiting four years buys a cheaper annuity rate per euro of income.
- She forgoes four more years of tax-free growth on €950,000 - at 5% that is over €200,000 of foregone fund.
- Drawing income now may reduce future flexibility and increases the chance she locks in a low lifetime tax-free cash entitlement if the lifetime limit is reduced.
Factors for vesting now:
- Tax-free cash at 20% vs 40% marginal rates in later years; using empty standard-rate bands; political risk to the €200,000 lifetime limit; the certainty of taking the cash before any change of rules.
File requirements: a written suitability statement comparing ARF and annuity (and the option of a vested PRSA, which offers a transfer route between providers), a documented capacity-for-loss and income-needs analysis, projections of the €25,000 net drawdown under a poor-markets scenario, the charges of the ARF provider disclosed in writing, and a signed acknowledgement that capital is at risk. Also confirm the cancellation position for the policy she is buying - a life-wrapped ARF carries the longer life-assurance cooling-off period, so the 30 November 'deadline' may not bind her in the way she thinks.