(This summary Guidance Note has been compiled by Revenue for information only and does not purport to be a legal interpretation of the statutory provisions governing the Standard Fund Threshold regime.)

At the outset, it should be noted that no tax consequences will arise for the vast majority of individuals with pension schemes, whether in the private or public sector, as a result of the changes to the Standard Fund Threshold (SFT) regime announced by the Minister for Finance in his 2014 Budget Statement and reflected in Finance (No.2) Bill 2013 published recently.

The changes to the SFT regime will not take effect until 1 January 2014, once the Finance Bill is passed into law.

What is the SFT Regime?

The SFT regime imposes a limit or ceiling on the total capital value of pension benefits that an individual can draw in their lifetime from tax-relieved pension arrangements, where those benefits come into payment for the first time on or after 7 December 2005.

The limit was set at £5 million when first introduced on 7 December 2005 and was subsequently reduced to its current level of £2.3m on 7 December 2010. In certain cases, individuals could avail of a higher limit or threshold (called a “personal fund threshold” or PFT). This arose if the individual’s pension rights on 7 December 2005 or 7 December 2010 exceeded the SFT applying at those dates.

How does the SFT regime work?

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.

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 (called a “chargeable excess”) is subject to an immediate tax charge at 41% (called “chargeable excess tax”). Any chargeable excess tax due has 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. The effective income tax rate on a chargeable excess can, therefore, be as high as 65%, excluding any liability to USC and PRSI.

What changes are being made in the Finance Bill?

Section 18 of the Finance Bill makes a number of changes to the SFT regime. The most important of these are:

• firstly, the absolute value of the SFT is being reduced, with effect from 1 January 2014, from £2.3m to £2m. However, as on previous occasions, an individual who has pension rights in excess of this new lower SFT limit on 1 January 2014, may claim a PFT from the Revenue Commissioners.
• secondly, the valuation factor to be used for establishing the capital value of an individual’s defined benefit (DB) pension rights at the point of retirement (i.e. at a BCE), where this takes place after 1 January 2014, is being changed from the current standard valuation factor of 20 to a higher age–related valuation factor that will vary with the individual’s age at the point at which the pension rights are drawn down. The age–related valuation factors are set out in the table below and range from 37 for DB pension rights drawn down at age 50 or under, to a factor of 22 where they are drawn down at age 70 or over.
• thirdly, in calculating the capital value of a DB pension at the point of retirement, a “split” calculation will apply where part of the pension had already been accrued at 1 January 2014 so that the part accrued up to that date (referred to in the legislation as the “accrued pension amount”) 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 (see below).

How is a PFT calculated?

The PFT is the sum of the capital values of all of an individual’s “uncrystallised” pension rights on 1 January 2014 i.e. pension rights that the individual is building up on that date but has not yet become entitled to. This would include rights under DB and defined contribution (DC) occupational pension schemes, AVCs, retirement annuity contracts and PRSAs. If the individual has already become entitled to pension benefits from any pension arrangements since 7 December 2005 (called “crystallised rights”) the capital value of those rights have to be included in the PFT calculation. Where, on 1 January 2014, the overall capital value of an individual’s pension rights exceeds the SFT of £2 million, that higher amount will be the individual’s PFT, subject to it not exceeding the previous SFT of £2.3m.

An individual who holds a PFT issued in accordance with the legislation as it applied before Finance (No.2) Bill 2013 is passed into law retains that PFT and there is no need to make a new application to Revenue.

How are pension rights determined?

In the case of rights arising under DC arrangements, the capital value for PFT purposes remains, as before, the value of the assets in the arrangement that represent the member’s accumulated rights on that date i.e. the value of the DC fund on that date.

Because members of DB arrangements do not have an individual “earmarked” fund, the capital value of pension rights arising under such arrangements has to be determined using a simple formula. Basically, you establish from the pension fund administrator the gross annual pension you would be entitled to under the rules of the DB arrangement if you retired on 1 January 2014 at your salary and service on that date and on the assumption that you had attained normal retirement age on that date. The gross annual pension is then multiplied by 20 (the standard valuation factor) to arrive at the capital value of your DB pension rights for PFT purposes.

If your 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 entitlement (calculated on the same assumptions as above) is added to the capital value of the DB pension to arrive at the overall capital value. It is important to note that the higher age–related valuation factors being introduced for determining the capital value of DB pension benefits at the point of retirement must not be used for PFT purposes.

The following simple examples illustrate the above concepts.

Example 1 Paul is a member of a DC pension arrangement. The value of his pension fund on 1 January 2014 (i.e. his uncrystallised pension rights) is £1m. He had not become entitled to any pension rights since 7 December 2005. As the value of Paul’s uncrystallised rights on 1 January is below the SFT of £2m, he cannot claim a PFT and the maximum allowable pension fund for tax purpose that Paul can build up is £2m.

Example 2 John is a member of a private sector DB pension arrangement. His pension fund administrator has indicated that, under the rules of the scheme, his accrued pension rights at 1 January 2014 would entitle him to a gross annual amount of pension (before any commutation for a lump sum) of £60,000, based on his salary and service on that date and on the assumption that he had attained normal retirement age on that date. The capital value of John’s uncrystallised pension rights on 1 January 2014 is, therefore, £60,000 multiplied by the standard valuation factor of 20, i.e. £60,000 x 20 = £1.2m. He had not become entitled to any pension rights since 7 December 2005. As the value of John’s uncrystallised pension rights on 1 January 2014 is below the SFT of £2m, he cannot claim a PFT and the maximum allowable pension fund for tax purpose that John can build up is £2m.

Example 3 Mary is a member of a DB pension arrangement. Her pension fund administrator has indicated that her accrued pension on 1 January 2014 based on her salary and service on that date and on the assumption that she had attained normal retirement age on that date, is £95,000 before any commutation for a lump sum. Mary also has DC pension arrangements with a value on 1 January 2014 of £300,000. The capital value of Mary’s uncrystallised pension rights on 1 January 2014 is, therefore, £2.2m i.e. DB rights of £95,000 x 20 = £1.9m + DC rights of £300,000. She had not become entitled to any pension rights since 7 December 2005. Mary can apply to Revenue for a PFT of £2.2m and that represents the maximum allowable pension fund for tax purpose that Mary can build up. Any future accrual of pension benefits by Mary in her DB arrangement and any future increase in the value of her DC arrangement, either through further contributions or fund growth, will give rise to a chargeable excess and be subject to chargeable excess tax.

Example 4 Jean is a member of a DC pension arrangement the value of which is £1.8m on 1 January 2014 (i.e. her uncrystallised rights). Jean had already drawn down pension benefits under a separate scheme on 1 July 2009 which had a capital value for BCE purposes of £0.7m at that date (i.e. her crystallised rights). The combined value of Jean’s crystallised and uncrystallised pension rights on 1 January 2014 is, therefore, £2.5m. This exceeds the SFT of £2m, so Jean is entitled to make a PFT application. However, Jean’s PFT will be restricted to a maximum of £2.3m (the current SFT limit). Jean’s maximum allowable pension fund at retirement is, therefore, £2.3m. The pension benefits she drew down in July 2009 have already used up £0.7m of her PFT leaving her with a PFT balance of £1.6m for use against her uncrystallised rights when she draws them down. Whether Jean ultimately has a chargeable excess will depend on how her remaining DC pension arrangement performs up to the point when she takes her benefits. On the assumption that the value of her uncrysatllised pension rights remains at £1.8m, she would have a chargeable excess at retirement of £200,000 (i.e. £1.8m – £1.6m).

How is the capital value of a BCE determined?

The approach is similar to that for calculating a PFT.

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. For example, in the case of an annuity, it is the value of the assets used to purchase the annuity while in the case of a retirement lump sum it is the value of the lump sum (before excess lump sum tax, if any).

In the case of DB pension arrangements, 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 (before commutation of part of the pension for a lump sum) 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, where part of the DB pension has been accrued at 1 January 2014 and part after that date, transitional arrangements allow the capital value of the pension at retirement to be calculated by way of a “split” calculation, so that the part accrued up to 1 January 2014 (called the “accrued pension amount”) will be valued at a factor of 20 and the part accrued after that date valued at the appropriate higher age-related factor. A condition of applying the “split” calculation is that the administrator concerned is satisfied from information and records available to the administrator that an accrued pension amount arises in relation to the DB pension in question.

The following simple examples illustrate the above.

Example 5 Michael is a member of a DC pension scheme. He has no PFT. Michael retires on 1 July 2015. The value of his DC fund on that date is £1.5m. As this is below the SFT of £2m no chargeable excess arises.

Example 6 Jim is a member of a private sector DB scheme. He retires on 1 February 2020 aged 65. The relevant age-related valuation factor applying to Jim is, therefore, 26. The annual amount of pension that his scheme would pay him on retirement (before any commutation of part of the pension for a lump sum) is £75,000. Jim’s pension fund administrator is aware that £50,000 of this pension had already been accrued at 1 January 2014 (i.e. the accrued pension amount). The administrator calculates the capital value of Jim’s pension rights at retirement for BCE purposes as follows:

£50,000 x 20 = £1m (i.e. accrued pension amount x the standard valuation factor)

£25,000 x 26 = £0.650m (pension accrued after 1 January 2014 x age-related factor)

Capital Value = £1.65m.

As the capital value of Jim’s retirement benefits based on the “split” BCE calculation is less than the SFT, no chargeable excess arises.

Example 7 Lucy retires at age 60. She does not have a PFT. Her annual DB pension at retirement is £90,000 (before commutation for a lump sum). The relevant age-related valuation factor applying to Lucy is, therefore, 30. Lucy’s pension fund administrator is aware that £45,000 of her pension had already been accrued at 1 January 2014 (i.e. the accrued pension amount). The administrator calculates the capital value of Lucy’s pension rights at retirement for BCE purposes as follows:

£45,000 x 20 = £0.900m (accrued pension amount x the standard valuation factor)

£45,000 x 30 = £1.350m (pension accrued after 1 January 2014 x age-related factor)Capital Value = £2.250m

Less SFT = £2.000m

Chargeable excess = £0.250

As Lucy has a chargeable excess of £250,000, she is liable to chargeable excess tax of £102,500 (i.e. £250,000 @ 41%). The pension fund administrator must pay this tax to Revenue upfront and recover it from Lucy.

What are the procedures for making a PFT application?

In the past the PFT application procedure was paper based. However, on this occasion a new electronic based application process is being developed by Revenue under which the relevant PFT information will have to be provided. For the purposes of the application an individual will be required to provide basic identifying information about him or herself and the various pension arrangements he or she is a member of. In addition, the individual will have to obtain from the administrator of each pension arrangement of which he or she is a member, a statement certifying the amount of the individual’s pension rights on 1 January 2014 relating to that arrangement, calculated in accordance with the provisions of the legislation. In the case of a DB arrangement, the individual will also have to indicate the annual amount of pension accrued at 1 January 2014 underpinning that calculation as certified by the administrator. Full details of the application requirements will be reflected in the electronic system when it is made available.

Is there a deadline for a PFT application?

The time limit for making a PFT application is 12 months after the date on which the electronic system is made available. So if the system is made available by, say, 1 February 2014, an individual will have until end-January 2015 to make an application.

The exception to this is where a person is entitled to a PFT and is retiring after 1 January 2014 and before the electronic application system comes on stream. In such cases, the existing paper based application process must be used and the application must be made in advance of retirement, otherwise the administrator is required to apply the SFT limit of £2m.

How does the administrator recover chargeable excess tax paid in the case of DB pension arrangements?

In the case of private sector DB pension arrangements, the legislation provides for the administrator to recover any chargeable excess tax paid either by way of an actuarial reduction in the individual’s pension rights or by arranging to be directly reimbursed by the individual.

In the case of public sector DB pension arrangements, a range of reimbursement options were introduced in Finance Act 2012 and these are being amended and extended in Finance (No.2) Bill 2013. Under the new arrangements the following options will be available.

Where the chargeable excess tax paid does not exceed 20% (previously 50%) of the net retirement lump sum (i.e. after excess lump sum tax, if any):

• by recovering it from the net lump sum, or
• by payment by the individual of a sum equivalent to the tax to the administrator, or
• by any combination of the above, or
• solely by way of a reduction in the gross pension payable to the individual over a period not exceeding 20 years (this is a new option).

Where the chargeable excess tax paid exceeds 20% (previously 50%) of the net retirement lump sum (i.e. after excess lump sum tax, if any):

• by retaining not less than 20% of the net lump sum, or
• by payment by the individual of a sum not less than 20% of the net lump sum to the administrator, or
• by any combination of the above, and
• by recovering any balance by reducing the gross pension payable over a period not exceeding 20 years (previously 10 years), or
• solely by way of a reduction in the gross pension payable to the individual over a period not exceeding 20 years (this is a new option).

Offset of excess lump sum tax against chargeable excess tax.

Under current rules, where an individual is faced with paying chargeable excess tax on his or her retirement benefits and standard rate tax on an excess retirement lump sum, the administrator is required to offset the excess lump sum tax against the chargeable excess tax. For example, if Sean has to pay chargeable excess tax of, say, £50,000 and also faces tax of £10,000 on his retirement lump sum, the administrator offsets the £10,000 excess lump sum tax against the chargeable excess tax so that Sean only has to pay net chargeable excess tax of £40,000 (i.e. £50,000 – £10,000). Overall, Sean’s tax liability is now £40,000 net chargeable excess tax and £10,000 excess lump sum tax. The facility to offset excess lump sum tax against chargeable excess tax is unchanged.

However, it should be noted that while under current arrangements the first £200,000 of a retirement lump sum is paid tax free, the amount of a lump sum in excess of that tax–free amount is taxed at a ring-fenced rate of 20% up to £575,000 and at the individual’s marginal rate on any amount above £575,000. The £575,000 cut-off point is, effectively, defined in the legislation as being 25% of the SFT. Therefore, as a consequence of the SFT being reduced to £2m from 1 January 2014, the cut-off point will automatically change to £500,000 on that date. As a result, while the tax-free amount of £200,000 remains unchanged, the 20% rate of tax will apply to amounts between £200,000 and £500,000 and marginal rate tax on amounts above £500,000.

Are there any sanctions for failing to comply with the legislation?

The Finance Bill introduces a fixed penalty of £3,000 for each failure on the part of a person to comply with any of the obligations imposed on the person by the legislation (Chapter 2C and Schedule 23B of the Taxes Consolidation Act 1997), for example failing to retain records for the required 6 year period.

Table of Relevant age-related valuation factors

Age	Factor	Age	Factor
50(and below)	37	61	29
51	36	62	28
52	36	63	27
53	35	64	27
54	34	65	26
55	33	66	25
56	33	67	24
57	32	68	24
58	31	69	23
59	30	70 (and above)	22
60	30

Source: Revenue Commissioners. www.revenue.ie. Copyright Acknowledged.