Money

Retirement can be a culture shock. Now is the time to take stock and plan the financial aspects well in advance to ensure a comfortable and rewarding retirement. Michael Ó Scathaill and Jonathan Ginnelly see the light

Readers will by now be aware that a legal practitioner contemplating retirement will encounter a wide range of issues, both tax and commercial, and that early engagement is critical.

The first two parts of this series set out some of the key issues to be considered during the preparatory phase and those that arise on the retirement itself. Part 3 now considers the post-retirement phase.

It is often noted that retirement can come as something of a 'culture shock', and many retirees struggle with what might loosely be referred to as the 'social challenges' of retirement.

These challenges are beyond the scope of this article, other than to note that experts in the field often cite the importance of taking stock and planning it out in advance in order to have a more comfortable and rewarding retirement – and this advice equally applies to the financial aspects.

Time

In the first instance, it's useful to set out a projection of your financial requirements in retirement and the income that will fund them.

Expenditure requirements will vary from case to case. Ordinarily, outgoings in retirement should be lower than during one's working life – for example, the mortgage on the family home may be paid off, the cost of commuting will fall away, etc.

However, while some costs may diminish, the retiree might have certain plans for retirement, such as travelling or taking up a new hobby that could require some financial outlay.

The sources of income will vary depending on the individual's circumstances. For most retirees, the key sources will be pension (private and State).

In some cases, as discussed earlier in this series, a practitioner may have retained their business premises from which they are now generating a rental income.

Some practitioners may have agreed to stay on in a consultancy role with their former firm for a period of time post-retirement and are, therefore, in receipt of a salary or consultancy fees. Various sources of investment income – dividends, interest, rents – can apply in some cases.

While the State pension receivable will be at the prevailing rate at the time (at the discretion of the Government of the day), the quantum of private-pension income will vary depending on the value of funds built up during the retiree's working life. (Readers may wish to refer to part 2 of this series – June Gazette, p48 – where the tax treatment of pension contributions and how pension provision might be boosted in the closing years, in particular, were considered.)

Another key feature of a private pension is the entitlement to draw down a lump sum at the outset. This has important tax as well as financial-planning implications, and is considered in some detail below.

It is important that this lump sum is factored in correctly when preparing projections of income and expenditure in retirement. For instance, the lump sum may be used to fund some one-off requirements, such as works on the family home or, perhaps, an exciting overseas expedition that has been envisaged for some time.

Assuming it is not all spent then, some may be reinvested or put into savings, with a view to gradually releasing it to provide an extra stream of income on an ongoing basis.

The pension may not be the only source of a lump sum: others include the repayment of the practitioner's capital account (an important issue that should be reviewed carefully and which is considered in more detail below) and, in some cases, the proceeds of sale of the business premises or where a capital payment has been received for practice goodwill.

It is important that it is the after-tax income that is compared with expenditure requirements. For the most part, other than the introduction of an age credit of €245 (or €490 for a married couple) at age 65, income-tax treatments do not change hugely in retirement.

There is an exemption from income tax where total income does not exceed €18,000 per annum (or €36,000 for a married couple) but, assuming that the State pension is not the only source of income, these thresholds are generally exceeded.

There are also reduced USC rates at age 70 where the individual's annual income (excluding State pension that is not subject to USC) is less than €60,000.

Any colour you like

On retirement, the practitioner will likely have a capital account built up. This is ultimately a reflection of their earnings over the years and is taxed income. Its withdrawal should not, therefore, give rise to any additional tax costs and can provide the retiree with a welcome financial boost.

The manner in which this capital account is accessed can differ, depending on the circumstances. In an ideal world, the retiring practitioner would withdraw the entire amount on retirement – this should be possible where, for example, the practice is simply being closed.

In other cases, however, such as where there is a successor taking over, or where the retiree was part of an existing partnership, the other practitioners may be less keen to distribute the entire amount upfront and, in those circumstances, it is important that a timeframe and structure is agreed for repayment – this with a view to avoiding any friction and to providing all parties with some cash-flow certainty.

Speak to me

The private pension is the likeliest other source of a lump sum and, in most cases, will be the main source of ongoing income in retirement. It therefore merits careful consideration, and specialist advice should be taken in advance on how best to access pension benefits.

While the rules of each scheme may vary, generally they allow up to 25% of the fund to be taken as a lump sum. Currently, such pension lump sums are exempt from income tax up to €200,000, with the remainder up to €500,000 being taxed at a rate of 20% and any element above €500,000 (uncommon in practice) being taxed at marginal rates.

These are cumulative thresholds, however, and it is important that any prior lump sums drawn down are factored in.

The remainder of the pension is then typically used to provide an income stream in retirement. Again, the nature and rules of the scheme must be considered but, normally, the choice is to either use the remainder of the fund to purchase an annuity or to transfer it to an Approved Retirement Fund (ARF).

The appropriate course of action varies, depending on individual circumstances, and should be considered carefully.

Us and them

An annuity can provide a guaranteed income stream in retirement, but consideration should be given to the annuity rates available. An ARF, on the other hand, can continue to reinvest with a view to generating further returns (albeit that a conservative investment strategy is generally applied, the ARF-holder having now retired) that are not subject to tax inside the ARF.

The imputed distribution rules require an ARF to apply payroll taxes (PAYE, USC, and potentially PRSI) on 4% of the fund value each year from age 61, rising to 5% at age 71, even if no distribution is actually made. In practice, therefore, in order to avoid double taxation, the ARF distributes at least this amount each year to the ARF-holder.

Careful consideration should therefore be given to when the pension benefits should be accessed and the fund transferred to an ARF/annuity.

One option that may be worth considering is splitting pension benefits between a number of funds and, initially, only accessing one fund, with the remaining funds being drawn down at a later date. They might, for example, draw down a fund that provides a tax-free lump sum of €200,000 and a sufficient income stream from the ARF (or annuity) for the next few years, allowing the other funds to potentially generate additional returns, and only draw them down (and trigger the additional tax costs) at a later date.

This is a complex area, and specialist and timely advice should be taken from a pensions specialist.

On the run

Another matter that requires specialist and timely advice is if an individual wishes to retire overseas or even wishes to divide their time between Ireland and another country.

This gives rise to a number of potential tax issues.

At the simplest level, the tax rules of the other country will have to be taken into account. Issues such as the overall tax regime in the destination jurisdiction will need to be confirmed.

If a significant amount of time is to be spent in Ireland as well, then the issue of dual-tax residency arises. In such instance, reliance on double-taxation treaties may be necessary in respect of potential double-taxation on income and gains.

The tax treatment of pension income will be particularly important. In principle, provided there is a double-taxation agreement between Ireland and the other country, pension income should generally only be taxable in the other country, and an exclusion order may be obtained to ensure that Irish tax is not withheld at source.

In practice, however, the position may not always be as straightforward, in particular where ARFs are concerned.

The impact on assets should also be considered, including the CGT treatment in both jurisdictions on a disposal of assets and, longer-term, the impact on inheritance-tax treatment. It would also be advisable to seek local legal advice on the matter of wills and estates.

The great gig in the sky

While at the beginning of what will, hopefully, be a long and happy retirement, 'wills and estates' might not be a topic that one would wish to dwell on too deeply; however, it is something that merits careful consideration.

Who you leave your assets to and when you do so (by way of gift or inheritance) can have significant tax, as well as other, consequences. Legal practitioners will, no doubt, understand the importance of this more than most.

Where you own assets outside Ireland, you should consider any potential inheritance-tax exposures in that jurisdiction. One of the most common jurisdictions in this regard is the United States, due to the very significant proportion that US equities account for in many investment portfolios.

Where US equities in excess of US$60,000 are owned by a non-US citizen at the time of their death, then an exposure to US federal estate tax will arise for their estate, even where the assets are passing to a spouse.

If you retire abroad, the inheritance-tax regime in your chosen jurisdiction, as well as legal provisions with regard to succession matters, will need to be considered. While Ireland has a broad network of double-tax treaties dealing with taxation of income and gains, the treaty network with regard to inheritance taxes is quite limited.

Ireland does allow unilateral relief for inheritance taxes in certain situations, but these provisions do not always fully mitigate double-taxation exposure. As such, if retiring abroad, a clear understanding of all relevant taxation provisions in the jurisdiction you intend to live in is important.

It will now be appreciated that, even after reaching the retirement milestone, there are still many issues to consider.

This series of articles began with the observation that taking a long-term approach and early engagement with the issues are key to a successful retirement. As we conclude, it is a message that we find ourselves reiterating.

Michael Ó Scathaill is a director of the owner-managed business service in the tax department at Crowe. Jonathan Ginnelly, partner, leads the private clients' service in the same department.