There is no more tax-efficient means of saving than putting money into a pension plan. Contributions to a pension are tax-free, up to certain limits depending on age and, if made regularly over a working life, can build to a pot large enough to provide sufficient income for a comfortable retirement.

Pensions are unique in savings products as cash added to them is generally locked away until the holder of the plan reaches pensionable age. While payments into a pension fund are made from pre-tax income, up to certain limits, the income from a pension plan after retirement is taxable. The exception to this is that a person is allowed to withdraw, tax-free, 25% of the value of their pension at retirement. This lump sum is capped at €200,000.

The most important thing about a pension pot is to make it as large as possible ahead of retirement and the best way to achieve this is to start putting money aside from as young an age as possible. Saving over a longer period also means that the size of monthly contributions can be smaller than if pension savings don’t start until later in life.

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While it might be hard to convince a 25-year-old to put money aside for when they retire, the difference the extra payments makes is significant. That 25-year-old could achieve a pension pot of €250,000 by contributing €400/month. For a 45-year-old, the month contributions would have to more than double to €900/month to achieve the same pool of money to fund their income after retirement.

The tax planning around pensions does take account of this change in contribution needs, with the amount of income which can be added tax-free to a pension increases with age.

Someone under 30 can put up to 15% of their income into a retirement plan tax-free, rising to 40% for someone over 60 (see Figure 1).

There is also an income threshold, currently set at €115,000, at which the tax-free allowance is limited. In practice, this means the maximum tax-free contribution someone over 60 can make annually to their pension is €46,000.

For someone under 30, that maximum is €17,250 (15% of €115,000). There is also a lifetime threshold set at €2.2m, which is set to rise to €2.8m by 2029.

It is worth noting that the tax relief only applies to income tax, and does not cover PRSI or the universal social charge (USC).

Once it comes to drawing down a pension, there is the option to taking a tax-free lump sum. The weekly (or monthly) pension payments after that are taxed as income. This means that if a worker was to contribute to their pension above their tax-free limits, then the money will end up being taxed twice – once on the way in and again on the way out.

For farmers who have their business incorporated, there are opportunities to make larger tax-free payments in a single year.

A pension plan known as a personal retirement savings account (PRSA), has its own set of rules under which it is possible to contribute up to 100% of a director’s salary.

The rules around these plans have changed several times in recent years, but they do give advantages over other retirement products under the right circumstances. As with all aspects of financial planning, it is critical to talk to a qualified, independent, financial adviser before making any pension decisions.

Auto-enrolment

The start of this year saw the introduction of the long-delayed auto-enrolment scheme for all employees.

From 1 January, all employees aged between 23 and 60, and earning more than €20,000 across all income sources, must be part of a pension plan.

If employees were already part of a suitable company pension plan, then no changes were required. In all other cases, then the employees will be entered in the auto-enrolment scheme.

The coverage of this includes farmers who have incorporated their business and are an employee of their farm.

The contributions to the auto-enrolment scheme comes from three sources: the employee, the employer and the Government. The ratio of payment is broken down on a 3:3:1 basis, where the employee and employer make matching contributions, while the Government adds one in every seven euro to the pot.

The size of the contributions is based on the employee’s salary. In the initial years of the scheme, it is 1.5% for both the employee and employer and 0.5% for the Government. By 2036, the contributions will have risen to 6% for both the employee and employer, with 2% from the Government (see Table 1).

This means that by 2026 an employer will be making €1,200 of pension contributions for every €20,000 an employee earns.

State pension

Whether you have a private pension or not, you will qualify for the State pension when you turn 66 – the current earliest age it can be drawn down.

Recent changes introduced by the Government mean you can delay the start of the drawdown of your State pension until you turn 70. By delaying the drawdown, an increased weekly payment can be achieved.

There are two types of State pension, the contributory and the non-contributory. The non-contributory pension is means tested and is currently worth €288/week for those aged 66-80 and €298/week for those over 80.

The contributory pension is mostly based on your lifetime PRSI contributions. In order to qualify for the maximum State contributory pension, you will need 2,080 full-rate PRSI contributions in your lifetime, which works out as 40 years of PRSI contributions.

The minimum required to receive any non-contributory pension is 520 PRSI contributions.

The contributory pension is not means tested, and is currently worth €299.30/week for those under 80 and €309.30 for those over 80 years of age. Whichever State pension a person qualifies for, it is clear that the income in retirement would be modest, once again underlining the need have a private pension plan in place in order to help with a comfortable retirement.