Terence Flanagan (Dublin North East, Independent)
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136. To ask the Minister for Finance the amount of excess fund tax payable in the following circumstances, public servant retiring on 1 January 2014 with €120,000 pension and €200,000 lump who dies after five years; private sector defined benefit scheme member with benefit entitlement, after commutation, of €120,000 pension and €200,000 lump sum, the pre-commutation pension was €140,000 and this person also dies after five years; private sector defined contribution scheme member with fund worth €4,984,190, based on current annuity rates, this would provide a lump sum of €200,000 and a pension of €120,000 per annum indexed, and this member also dies after five years; and if he will make a statement on the matter. [53674/13]

Michael Noonan (Limerick City, Fine Gael)
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At the outset, I should say that the scenarios outlined in the question, albeit that they are purely hypothetical, may be based on a misapprehension of how the Standard Fund Threshold (SFT) regime operates in practice. To try to answer the questions posed, it is necessary to make assumptions about how the individuals concerned managed, in the period prior to retirement, any possible exposure to chargeable excess tax. Given the size of the assumed benefits, it is reasonable to take the view that each individual would have sought a Personal Fund Threshold (PFT) in 2010, when the SFT was reduced from €5.4m to €2.3m. This would have allowed them to "grandfather" the pension rights they had built up at that point in time and thus protect them from chargeable excess tax on the PFT amounts.

By way of illustrating this point, take the details in the question relating to the public servant retiring on 1 January 2014 on a defined benefit (DB) pension of €120,000 and a separately accrued lump sum of €200,000 (as per the example - even though the lump sum would, in fact, be three times the pension i.e. €360,000, under normal public service pension scheme arrangements). Assuming that he or she was retiring after a full 40 year career, then that individual would have had an accrued annual pension and lump sum entitlement on 7 December 2010 (the previous opportunity for claiming a PFT) of some €111,000 and €185,000 respectively (assuming say 37 years service at that time). The capital value of those pension rights would, therefore, have been around €2.4m, and as this exceeded the then SFT of €2.3m applying from 7 December 2010, the individual would have claimed a PFT from Revenue which would have fully protected the individual from chargeable excess tax on that amount at the point of retirement. Thus, assuming the individual acted rationally and sought a PFT of €2.4m, the chargeable excess would be €200,000 and the chargeable excess tax would be €82,000.

In the same way, the private sector DB scheme member, again on the assumption that he or she was retiring after a full 40 year career, would have accrued a pre-commutation annual pension of some €129,500 at 7 December 2010, with a capital value of €2.590m at that date (i.e. €129,500 x 20) which he or she could have protected with a PFT. In this instance, on the face of it (but subject to the comments made later), the chargeable excess would be €210,000 and the chargeable excess tax would be €86,100.

It is also necessary to assume that the private sector defined contribution (DC) scheme member would have sought a PFT. For illustrative purposes, assume that this individual’s fund was built up steadily over a forty year career, meaning that on 7 December 2010, the fund was worth somewhere in the region of €4.6m. As the capital value of the fund was above the then SFT of €2.3m and did not exceed the old SFT of €5.4m, the individual could have sought a PFT for the full amount of the fund i.e. €4.6m. (In practice, of course, the value of the DC fund at that time could have been greater or lesser than this amount). On these assumptions (again subject to the comments below) the chargeable excess would be of the order of €400,000 and the chargeable excess tax would be some €164,000.

However, the scenarios illustrated in the question are unlikely to arise in practice, in the case of both the private sector DB and DC fund members, because the purpose of the SFT regime is to restrict the excessive build up of pension savings through tax relieved sources. It achieves this by imposing penal tax charges on the value of retirement benefits above set limits (i.e. the SFT or PFT) when they are drawn down, thus discouraging the building up of large pension funds in the first place. All the indications are that the pension funds of highly paid private sector individuals are being actively managed in this way, with a view to avoiding a chargeable excess and the penal tax charges that go with it. Any individual in the private sector at risk of incurring a liability to chargeable excess tax is highly likely to act rationally and stop accruing pension benefits or stop making pension contributions and negotiate alternative immediate taxable compensation with their employer instead. All of the evidence suggests that this is what has been happening and is likely to continue to happen.

The position in the public service is different. Public servants cannot avoid the penal tax charge as they have no means of ceasing to accrue benefits under their schemes in order to prevent a breach of the SFT or their PFT, if they have one.

It was for that reason that I introduced in Finance Act 2012 a more flexible reimbursement option for public servants affected by chargeable excess tax and extended it in Finance (No.2) Bill 2013. I should stress that these reimbursement options do not remove or reduce the tax liability arising on a chargeable excess but provide more flexible options for the recovery of the tax liability by the pension scheme administrator. These options involve effectively spreading the recovery of the tax, paid up front by the public service pension administrator, over a longer period. It is the case, however, that, in the event of the death of a public servant before full recovery of the tax, any outstanding amount effectively "dies" with the individual but, in such cases, of course, the Exchequer benefits by not having to pay out the member's pension in the future.

As regards private sector DB schemes, in the event that a significant chargeable excess tax bill were to arise, the scheme administrator would also have to pay the tax over to Revenue up-front. In that regard, the legislation is not prescriptive as to how recovery of chargeable excess tax so paid by a private sector pension fund administrator is to be accomplished, other than requiring the individual's rights under the pension arrangement to be reduced to fully reflect the tax so paid or for the individual to reimburse the administrator directly. If recovery from the scheme member is by way of an actuarial reduction in the pension payable to the member, then it would appear that the recovery would cease on the death of the member. While the issue of the recovery of chargeable excess tax by private sector DB pension fund administrators has never been raised as a serious issue with my Department (because chargeable excess tax should, generally, not arise in the first place), I would say that if it should transpire that the means of recovery of chargeable excess tax in private sector DB schemes emerges as a problem for members, then I will consider any practical solutions that might be suggested.

In the case of private sector DC schemes, the issue of recovery of chargeable excess tax paid by the administrator does not arise, as it would simply have been paid directly from the individual's pension fund. On that point, while the example in the Question has the private sector DC member purchasing an annuity with his or her pension fund at retirement, it is highly unlikely that this would, in fact, be the case. This is because, in contrast to individuals in DB schemes, whether private or public service, the DC individual has the option to invest his pension fund, after taking the retirement lump sum, into an Approved Retirement Fund. He or she thus benefits from being able to retain his or her remaining pension fund capital "intact" after death for the benefit of his or her spouse and children through the Approved Retirement Fund facility.

The other important point that the question illustrates is the major criticism levelled at the existing SFT regime. This is that the fixed rate conversion factor of 20:1 currently used for converting defined benefit pension rights to a capital sum equivalent is inequitable relative to defined contribution pension arrangements, given the higher market annuity rates that those with defined contribution arrangements could face if they were to purchase annuities. I have made changes in the Finance Bill by way of moving, after 1 January 2014, to higher age-related valuation factors that vary according to the individual's age at the point the benefits are drawn down. These changes will, for the future, substantially improve the equity between defined contribution and defined benefit arrangements and as between those who retire at younger ages and those who retire later in life.