Róisín Shortall (Dublin North West, Independent)
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184. To ask the Minister for Finance further to the arrangements announced in budget 2014 relating to pension pot size, pension contributions and so on, the way the proposed changes will impact on the pension tax relief regime currently applied to civil servants earning €125,000, €150,000 and €200,000 respectively. [46270/13]

Róisín Shortall (Dublin North West, Independent)
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185. To ask the Minister for Finance further to the arrangements announced in budget 2014 relating to pension pot size, pension contributions and so on, the way the proposed changes will impact on the pension tax relief regime currently applied to members of the Cabinet. [46271/13]

Michael Noonan (Limerick City, Fine Gael)
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I propose to take Questions Nos. 184 and 185 together.

As both questions 184 and 185 relate to the changes to the Standard Fund Threshold (SFT) regime announced in my 2014 Budget Statement and reflected in the recently published Finance (No.2) Bill 2013, I propose to deal with them together. I should state at the outset that there is insufficient detail in the questions to allow for anything other than a general response.

The primary purpose of the changes I am making to the SFT regime is to further restrict the capacity of higher earners to fund or accrue large pensions through tax-subsidised sources. The SFT regime addresses the problem of pension overfunding and excessive pension accrual by dealing with it at the point of pension drawdown in retirement rather than by applying restrictions to pension savings or accrual upfront. The regime achieves this by imposing a penal tax charge on the value of retirement benefits above set limits when they are drawn down. In this way it acts to discourage the building up of large pension funds in the first place or unwinds the tax advantage of such overfunding by clawing back, through the penal tax charge, the tax relief granted.

The changes I am making can be summarised as follows;

- firstly, the absolute value of the SFT is being reduced, with effect from 1 January 2014, from €2.3m to €2m,

- secondly, the valuation factor to be used for establishing the capital value of defined benefit (DB) pension rights at the point of retirement, where this takes place after 1 January 2014, is being changed from the current standard valuation factor of 20 to a range of higher age–related valuation factors that will vary with the individual’s age at the point at which the pension rights are drawn down,

- thirdly, in calculating the capital value of a DB pension at the point of retirement, transitional arrangements provide for a “split” calculation where part of the pension had already been accrued at 1 January 2014 so that the part accrued up to that date will be valued at a factor of 20 and the part accrued after that date valued at the appropriate higher age-related valuation factor,

- finally, the reimbursement options, introduced in Finance Act 2012, for public servants affected by chargeable excess tax are being amended and extended.

As occurred on the occasion of the introduction of the SFT regime in 2005, and again when the value of the SFT limit was reduced to €2.3m in 2010, the legislation contained in the Finance Bill provides for an individual who has pension rights on 1 January 2014 in excess of the new lower SFT limit of €2m, to claim a Personal Fund Threshold (PFT) from Revenue in order to protect or “grandfather” the value of those rights on that date. This is subject to a maximum PFT of €2.3m, and individuals with PFTs from 2005 or 2010 retain those PFTs.

As before, the “grandfathering” provisions contained in the legislation reflect legal advice from the Attorney General. However, unlike previous occasions, the grandfathering arrangements this time around had to take cognisance not just of the reduction in the absolute level of the SFT from 1 January 2014, but also of the increase, from that date, in the factors for converting DB pension rights into capital value equivalents. It is for that reason, lest there be any suggestion that the changes had retrospective application, that DB rights accrued up to 1 January 2014 are to be capitalised at the existing valuation factor of 20, both for the purposes of determining if there is a PFT and for the purposes of placing a capital value on those rights at the time of retirement, where that takes place after 1 January 2014.

The changes and grandfathering arrangements outlined above apply, as appropriate, to both DB and defined contribution (DC) pension arrangements in both the private and public sectors. As regards DB pension arrangements, it is irrelevant whether an individual is a higher paid civil servant, a Cabinet Minister or a highly paid member of a private sector DB scheme, the same SFT rules apply to all such arrangements.

Specifically, the new lower SFT limit will apply to both DC and DB arrangements. Those in DC pension arrangements can seek a PFT from Revenue if the capital value of their arrangements exceeds €2m on 1 January 2014, subject to a maximum PFT of €2.3m. If the value of their DC pension arrangements is below the SFT on 1 January 2014, their funds can continue to accumulate up to €2m through further tax-relieved pension contributions and fund growth, subject to the various annual contribution and earnings limits that apply, without any risk of a chargeable excess arising. Members of DB pension arrangements can equally aspire to a maximum “tax–relieved” fund of €2m. However, in the case of DB pension arrangements, members of such arrangements do not have individual “earmarked” funds (as is the case in DC arrangements) and this, coupled with the fact that pension benefits in such arrangements reflect a “benefit promise” based on salary and service, dictates that the capital value of pension rights arising under such arrangements has to be determined in some other way.

The SFT regime provides (and has always provided) a simple formula for this purpose. The formula essentially requires the annual amount of pension payable to an individual under the arrangement to be multiplied by a valuation or capitalisation factor in order to establish the capital value, both for PFT purposes and for the purposes of establishing the value of DB pension rights at the point of retirement. Up to now, a single valuation factor of 20 has been used for these purposes. In light, however, of the major criticism levelled at the existing SFT regime, that the fixed rate conversion factor of 20:1 was inequitable relative to DC pension arrangements given the higher market annuity rates that those with DC pension arrangements could face if they were to purchase annuities, I have moved to introduce higher age-related factors. This will substantially improve the equity between DC and DB arrangements and as between those who retire at younger ages and those who retire later in life. These are significant changes.

The value of DB pension rights accrued up to 1 January 2014 will, under the grandfathering requirements, be valued for the purposes of the SFT regime at the existing factor of 20. If the capital value so determined exceeds the new lower SFT limit of €2m, such individuals may seek a PFT from Revenue, subject to the overall limit of €2.3m referred to earlier. In such cases, additional pension benefits accrued after 1 January will be valued using the relevant higher age-related factor and will, as for DC arrangements, be fully exposed to chargeable excess tax. Where the capital value of DB rights is less than €2m on 1 January, such individuals may continue to accrue pension rights up to the SFT limit but those additional rights will be valued at the relevant higher age-related factor.

Whether DB or DC arrangements are involved, on each occasion that an individual becomes entitled to receive a benefit under a pension arrangement for the first time (called a “benefit crystallisation event” or BCE) they use up part of their SFT or PFT, as the case may be. At each BCE, a capital value has to be attributed to the benefits that crystallise and the value is then tested against the SFT or the individual’s PFT, as appropriate, by the pension scheme administrator. For DC pension arrangements, the capital value of pension rights when they are drawn down after 1 January 2014 is simply the value of the assets in the arrangement that represent the member’s accumulated rights on that date, in other words the value of the DC fund at the point of drawdown. In the case of DB pension arrangements, the default position is that the capital value of such rights drawn down after 1 January 2014 is determined by multiplying the gross annual pension that would be payable to the individual by the appropriate age-related valuation factor. If the DB arrangement provides for a separate lump sum entitlement (otherwise than by way of commutation of part of the pension) e.g. most public service schemes, the value of the lump sum is added to the capital value of the DB pension to arrive at the overall capital value.

However, reflecting the grandfathering requirements referred to earlier, where part of the DB pension has been accrued at 1 January 2014 and part after that date, the transitional arrangements provide for the part accrued at 1 January to be valued at the factor of 20 and the part accrued after that date at the appropriate higher age-related factor.

When the capital value of a BCE, either on its own or when aggregated with earlier BCEs, exceeds the SFT, or an individual’s PFT, the excess is subject to an immediate tax charge at 41%, whichhas to be paid upfront by the pension fund administrator and recovered from the individual. In addition, when the remainder of the excess is subsequently drawn down as a pension (or, for example, by way of a distribution from an Approved Retirement Fund or vested Personal Retirement Savings Account) it is subject to tax at the individual’s marginal rate, thus giving rise to an effective income tax rate on a chargeable excess of some 65%, excluding any liability to USC and PRSI.

The Finance Bill also amends and extends the reimbursement options, introduced in Finance Act 2012, for public servants affected by chargeable excess tax who are required to reimburse the public sector pension fund administrator for the upfront payment of the tax to Revenue. Unlike affected individuals in the private sector, public servants cannot minimise or prevent the breaching of the SFT or PFT by ceasing contributions or benefit accrual. The focus of the changes is to reduce the amount that can be recovered from the net retirement lump sum payable to the individual to a maximum of 20% of the net lump sum (from 50%) and to include the option of reimbursement of the pension fund administrator solely by way of a reduction in the gross pension payable over a period not exceeding 20 years.