Making Cents: Apply the trivial rule to pensions

THIS week I will take a look at some questions submitted by Limerick Leader readers that I will do my best to answer.

Question: Liam, my wife is 63 and has a very small pension fund of about €3,500 and we’re not sure what she can and should do with it. She has no other pensions and it doesn’t form any part of our retirement planning but just wondering what are her options?

Answer: When it comes to pensions, there is a particular rule that would apply to your wife’s pension and I think she should use it, and it’s called the Trivial Rule.

What it allows your wife to do, is take 25% of her fund tax free, which she should do anyway, but with the balance rather than using it to pay herself an annual income which would be very small i.e. c. €105 per year, she could just take it as a taxable lump sum.

But here’s the thing, she’d only have to pay 10% tax on the balance rather than whatever your marginal rate of tax is. If your marginal rate of tax was at the higher rate of tax, she’d end up giving c. 47% (income tax and USC) of it away, which would mean of the €3,500 she has, she’d end up with c. €2,266.

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Using the Trivial Rule, she’d still get €875 tax free, but rather than paying 47% tax on the balance, she only has to pay 10% tax, which would be €263.

So, using this rule, she’d end up receiving €3,237 of her €3,500.

In order to avail of this rule, the total benefits payable from a pension fund, after the 25% tax free portion is paid, must not exceed €330 per year. And a pension company will calculate what that amount is based on single life annuity rates.

I was quoted by one pension company an annuity rate of 5.247% for a 63-year-old female which would mean your wife’s annual income using this rate would be c. €77.70 per year, which is under the €330 threshold so the Trivial Rule is available to her and one I would recommend she take advantage of.

Question: Liam, I’ve noticed from a bank statement that my parents received that they are paying DIRT tax on their savings. Now the amount they are paying is minuscule given that they are earning little or no interest, but I thought I read or heard somewhere before that because of their age, he’s 74 and she’s 71, that they wouldn’t have to pay DIRT tax.

Answer: You heard correct.

People over the age of 65 can get the interest they earn on savings, paid without the deduction of DIRT, provided their combined annual gross income, including the interest earned on savings accounts, is not greater than €36,000.

This entitlement isn’t automatic, so your parents have to apply for it and you do so by completing a Form DE1 and returning it to, the financial institution they have monies with. They don’t return this form to Revenue which is the mistake some people make.

And if they want to make a claim for DIRT that was deducted in previous years (they can go back four years) they must complete a Form 54 Claims and return it to their local Revenue office, who will process the claim and if successful, will send your parents a refund.

Question: Liam, I’m getting a bonus from my employer which will be about €3,624. Would I be better off taking it as cash and using towards a house purchase and reducing the size of my mortgage or using the full amount which I can use to purchase company shares and make an AVC pension contribution.

If I choose this option, I’ve been told the full €3,624 can be used. My gut is telling me to buy shares and make an AVC contribution but I’m not sure of the mechanics of figuring out which is best. Your help would be much appreciated.

Answer: Your gut is right and let me tell you why.

If you take the bonus in cash, it’s likely you’ll end up with half which leaves you with c. €1,812 which can be applied to a mortgage and can reduce your borrowings by that amount. And if you did, what impact would that €1,812 have on your monthly repayment?

The answer is it would lessen your repayments by €8.59 per month because you are borrowing that much less.

This calculation by the way is based on a rate of 3% over a term of 25 years.

And as a consequence of borrowing less, you’d also end up paying €766 less in interest payments.

So, the financial impact of using this €1,812 towards a mortgage is lower monthly mortgage repayments which we know would be €8.59 and over 25 years that’s €2,577 less. And lower interest payments which we know is c. €766.

When you combine both, the total saving would be about €3,343.

On the flip side if you use your bonus to invest in the share scheme and contribute a portion to AVC’s as well, we know that amount isn’t taxed and you have the full amount available i.e. €3,624.

If that amount was invested over a 25-year term i.e. same as the mortgage term I just referred to, and the growth was just 3% per year (I’m sure it would be a lot more but let’s run with a small figure) the amount you’d end up with would be €7,665.
When you stand both alongside each other, you would save €3,343 in interest and lower payments if used towards a mortgage, but you’d probably earn c. €7,665 if used towards share purchase and pension contributions.

So, it’s clear to me that using your full bonus towards share purchase and pension contributions is financially better for you, and if you want to put a number on it, it’s €4,322 more.

So my advice is to use your full bonus towards share purchase and pension rather than giving away 50% of it and using it towards a lower mortgage repayment. It’s just not impactful enough if you do.

Question: Liam, I’m 25 and need help trying to figure out how much of an emergency fund I should have in place and what type of account I should be saving into.

My net monthly income is €2,300 and I save €162.50 per month into my employers share purchase scheme and I try to save €50 into a Credit Union account. I have €4,217 in savings at the moment.

Answer: I think having a three times your net monthly income i.e. €7,200, as your emergency fund target is a good one.

And at the rate you’re saving and what you’ve accumulated so far, you should reach that target in about 14 months’ time.
The share purchase scheme you are saving into is a good mechanism because you are buying your company’s shares at a 15% discount which is very valuable, provided the share price doesn’t decrease in value by more than 15% that is.

Anyway, I would continue on with it and the same with the €50 into the Credit Union as well. Reaching that emergency fund number is too important to put your savings at too much risk.

So, keep doing what you’re doing, don’t make things complicated for yourself by changing anything, what you’re doing is absolutely fine and well done.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or www.harmonics.ie