Insights 29th Sept 2024

Senior public servants, business owners and those in defined benefit pension schemes will be the main beneficiaries of the decision by the Department of Finance to increase the Pension Standard Fund Threshold (SFT) to €2.8m by 2029. Legislation to enact these changes will likely be included in this year’s Finance Act.

The SFT was introduced in December 2005 to place a lifetime limit on the total capital value of pension benefits that an individual could draw from tax relieved pension products. Where an individual breaches the lifetime cap at retirement, the excess is subject to penal taxation at an effective income tax rate in the region of 70% — of which 40% is incurred upfront, with the remaining balance collected on drawdown.

The SFT was initially set at a level of €5 million, with provision made for it to be indexed at regular intervals thereafter in line with an earnings factor. While it was indexed up to a high-water mark of €5.4 million, the financial crisis intervened and the SFT was reduced to €2.3 million in 2010 and to €2 million in 2014. 

In late 2023, then Minister for Finance, Michael McGrath announced the “commencement of a targeted review of the Standard Fund Threshold (SFT) regime” led by “an independent expert, Dr. Donal de Buitléir, with support from the Department of Finance.”

This review was apparently instigated when the Government was left red faced when no senior Garda applied for the role of Deputy Garda Commissioner mainly due to the penal taxation of pension benefits. In the public service, senior Gardaí are particularly affected as they have to retire at 60, so the capitalisation factors used in determining the value of their pension against the €2m cap are less favorable.

The review by Dr. Donal de Buitléir was published in the past few weeks and makes significant recommendations regarding the Standard Fund Threshold (SFT) and limits on pension tax reliefs. The Minister for Finance, Jack Chambers, also issued a statement on the review on the same date.

Whilst the review called for an increase in the SFT to €2.8m in one go, and then to increase it annually in line with growth in average weekly industrial earnings, the Department of Finance has decided to stagger the increase. The Minister has decided on a phased increase in the SFT to €2.8m by 2029, starting in 2026 at €2.2m with further annual increases of €200,000 in 2027, 2028 and 2029 to reach €2.8m by 2029. An automatic annual adjustment of the SFT will apply thereafter in line with future income increases at a rate to be set annually by the Minister for Finance.

There would therefore appear to be no immediate increase in the threshold for 2025, a point which has been criticized by senior public servants. No rationale has been given as to why the first increase won’t take place until 2026 but further clarity on the point may emerge in the weeks ahead.

The review by Dr. de Buitléir also called for a reduction in the factors used to value a defined benefit pension accrued after 1st January 2014. For example, the current capitalisation factor for public service and defined benefit pension at 65 is 26. The review has recommended that this rate should be reduced to a more favorable rate of 19. The Minister has decided that an independent evaluation of new lower age-related valuation factors proposed in the report will be undertaken. It is, however, not clear when the new lower factors will apply from.

It also looks likely that the current maximum lump sum entitlement of €500,000 will be maintained, with €200,000 tax free and the balance of up €300,000 taxed at 20%. So, it appears that a retiree who has accumulated a pension fund of €2.8m in 2029 will not be entitled to take €700,000 (25% of their fund) as a lump sum. They will instead be entitled to €500,000; €200,000 tax free and the balance of €300,000 taxed at 20%.

Finally, and interestingly, the review by Dr. de Buitléir recommended the removal of the €115,000 relevant earnings limit for pension contributions and the removal of age-related limits for pension contributions on a phased basis. The Government has noted these recommendations and intends to establish an interagency group to review them in more detail.

Currently, the pension contribution limits for individuals are based on a percentage of pensionable earnings of up to €115,000. Personal  contribution rates are also linked to your age. Even an increase in line with the SFT would see the limit increase from €115,000 to €161,000 by 2029. This would still fall well short of the €275,000 limit that applied as far back as 2008, representing a reduction of over 58% in the annual earnings cap from its peak.

For the vast majority of workers, the ability to fund a pension anywhere close to €2.8m will be insurmountable throughout their working lives. The Irish Association of Pension Funds (IAPF) DC survey from 2020 suggested at the time that an average total contribution paid for employees of DC Schemes was between 10% and 11% or earnings.

In summary, the increase in the SFT is certainly welcome but it will only impact a very small portion of the workforce in this country, mainly senior public servants, business owners and those in Defined Benefit Pension Schemes.

An opportunity to increase or remove the earnings cap of €115,000 appears to have been missed for now, which would allow individuals to build up sufficient funds aligned with an increased SFT and to give them access to an appropriate and fair level of retirement income. We await the publication of the Finance Bill 2024, which will probably happen in early to mid-October 2024 to see what further pension recommendations might be included for 2025.