Taxation of Retirement lump sums
Retirement lump sums above €200,000 will be taxed with effect from 1 January 2011.
The new taxation regime for retirement lump sums replaces the existing regime which placed a lifetime limit on the amount of tax-free pension lump sums that could be taken by an individual from 7 December 2005. This limit was set at 25% of the old Standard Fund Threshold and amounted to about €1.35 million.
Under the new approach, the maximum lifetime retirement tax-free lump sum will be €200,000 as and from 1 January 2011. Amounts in excess of this tax-free limit will be subject to tax in two stages. The portion between €200,000 and €575,000 will be taxed at the standard rate of income tax in force at the time of payment, currently 20%, while any portion above that will be taxed at the recipient’s marginal rate of tax.
The figure of €575,000 represents 25% of the new lower Standard Fund Threshold of €2.3 million. The standard rate charge is "ring-fenced" so that no reliefs, allowances or deductions may be set or made against that portion of a lump sum subject to that charge.
Although tax free lump sums taken after 7 December 2005 (when the original limit was introduced) and before 1 January 2011are unaffected by the new rules, they will count towards "using up" the new tax free amount. In other words, if an individual has already taken tax- free retirement lump sums of €200,000 or more since 7 December 2005, any further retirement lump sums paid to the individual on or after 1 January 2011 will be taxable. These earlier lumps sums will also count towards determining how much of a lump sum paid on or after 1 January 2011 is to be charged at the standard or marginal rate as appropriate.
It is also important to note that the €200,000 tax–free amount is a lifetime limit and so it will apply to a single lump sum or where an individual is in receipt of lump sums from more than one pension product, to the aggregate of those lump sums. The restriction also applies to all pension arrangements, including occupational pension schemes, Retirement Annuity Contracts, PRSAs, public sector and statutory schemes.
There are certain exclusions from the pension lump sum tax charge. It will not apply, for example, to lump sum death-in-service benefits paid to a widow or widower, civil partner (within the meaning of the Civil Partnership and Certain Rights and Obligations of Cohabitants Act 2010), children, dependants, or personal representatives of a deceased person.
The following examples illustrate how this new scheme will work in practice.
Example 1
A is paid a retirement lump sum on 10 January 2011 of €180,000. This is the first such lump sum he has received. A’s retirement lump sum is exempt from tax as it is less than the tax-free limit of €200,000. He has, however, used up €180,000 of his lifetime tax-free limit.
Example 2
A is paid a further retirement lump sum of €150,000 on 30 June 2011. As the tax-free limit applies to the aggregate of all lump sums received on or after 7 December 2005, A must aggregate both lump sums to determine how much of the second lump sum is subject to tax. The aggregate of the lump sums received since 7 December 2005 is €330,000. This exceeds his lifetime tax-free limit of €200,000, by €130,000. The "excess lump sum" of €130,000 is, therefore, subject to tax at the standard rate of tax for 2011 i.e. 20%
Example 3
A is paid a further retirement lump sum of €450,000 on 30 September 2011.
As illustrated in Example 2, his lifetime tax-free limit of €200,000 has been fully used up and he has also used up €130,000 of the amount that is charged at the standard rate (i.e. €375,000; the difference between the tax free limit of €200,000 and €575,000 (25% of the SFT)). The latest lump sum is subject to tax as follows:
- €245,000 @ the standard rate for 2011 (€375,000 – €130,000 = €245,000).
- the remaining €205,000 @ his marginal rate for 2011.
Example 4
B is paid a retirement lump sum of €800,000 on 31 January 2011. This is the first such lump sum he has received. He is charged to tax as follows:
- the first €200,000 is exempt,
- the next €375,000 is taxed at the standard rate for 2011
- the balance i.e. €225,000, is taxed at his marginal rate for 2011.
If B receives any future retirement lump sum, it will be subject to tax at his marginal rate in the year it is paid.
Example 5
C is paid a retirement lump sum on 10 January 2011 of €100,000. She had previously received a lump sum on 30 June 2009 of €300,000. As C’s earlier lump sum already exceeds the tax-free limit all of the latest lump sum is taxable. The €100,000 lump sum taken on 10 January is taxable at the standard rate of 20%. The earlier lump sum is unaffected.
Example 6
D is paid a retirement lump sum on 1 July 2011 of €400,000. He had previously received a retirement lump sum of €500,000 on 1 January 2006. The earlier lump sum has "used up" all of D’s tax-free limit of €200,000 so that all of the lump sum taken on 1 July is taxable. Even though the earlier lump sum is not taxable, it affects the rate of tax applying to the later lump sum. The earlier lump sum has "used up"
the €200,000 tax free limit, and
Therefore:
€300,000 of the €375,000 that is taxable at the standard rate
€75,000 of the later lump sum is taxed at the standard rate
the remaining €325,000 of the later lump sum is taxed at D’s marginal rate.