Veleta

I wonder if anybody here has an indepth knowledge of how private pensions in Spain work.

I have had one with INGDirect (Spain) for a few years now. I took out the plan thinking that it must be a good thing to do (I know it hasn't performed well recently, but it is still another 30 years before I retire so don't care about short term performance).

Anyway, my query is this. I know that whatever money I choose to put into my pension is exempt from IRPF, thereby saving myself the corresponding 18% (or thereabouts) tax per year. However, I understand that when I come to withdraw this money 30 years from now it will be taxed at the higher rate of 43% (or thereabouts).

So why am I saving 18% now, to pay 43% when I retire? Where is the benefit of this?

jdr

You may find you dont get the money in thirty years time and you can only have a tax free lump sum, like about one quarter of it and use the rest to buy a monthly pay out pension.

Veleta

Have you heard that it is possible to get a tax free lump sum?

I get conflicting information, but the latest thing I have been told is that I can either take the full amount as a lump sum, all taxed at 43%!!!! or have it paid out to me in installments, but also fully taxed.

jdr

I have just done one, but it is British, tax free lump and the rest monthly like a pension and taxed if you get too much income.

Veleta

Ok, thanks. But what I really want to know is how the Spanish private pensions work. If what I am told is correct, why would I want to pay into the pension now and save myself 18% IRPF, if when I take the money out again I will be taxed at 43%.

Maybe I am just not understanding the system correctly.

jdr

Maybe Fred will be along soon to help you.

iant

Without going into too much detail, you are allowed to deduct from your net earnings each year the amount of contributions paid into the pension plan that year, up to 10,000 euros or 30% of net earnings. This means that you are "saving" tax on that part of your income. When you reach 65, and provided you recover the value of the plan in a lump sum, you will be subject to income tax on 60% of the amount so recovered. In other words, you have been deferring payment of tax on that 60% part and have "saved" tax on the 40%.


Should you decide to recover the proceeds of the plan as an annuity, then the 40% saving does not apply and the annual amount of the annuity received is fully taxable as part of your income for the year.
Sounds complicated, but its not really.

Hope this helps.

iant

Veleta

Thanks Ian. This does help, but you are right...it does sound complicated.

"Without going into too much detail, you are allowed to deduct from your net earnings each year the amount of contributions paid into the pension plan that year, up to 10,000 euros or 30% of net earnings. This means that you are "saving" tax on that part of your income. " Understood.

"When you reach 65, and provided you recover the value of the plan in a lump sum, you will be subject to income tax on 60% of the amount so recovered. In other words, you have been deferring payment of tax on that 60% part and have "saved" tax on the 40%." Let's assume I will take it as a lump sum. So 40% of that fund is tax free. The remaining 60% will be taxed, and it will be taxed in the highest tax band which I think is 43%. So on this 60% I am saving having to pay 18% IRPF now, but will have to pay 43% IRPF when it matures.

Am I getting the gist of this right?

iant

Assuming that you are tax resident in Spain,the tax you are saving now is at the highest rate applicable to your income, I dont know where you are getting the 18% from. That rate is used for investment income, but your contributions to a pension plan are offset against your earned income, which will suffer income tax at a rate depending on the level of your income.

iant

Veleta

Hi Ian

Yes, I am a tax resident in Spain.

I'm not totally sure what my income tax rate is, but I think I had read somewhere it was 18%. Perhaps not, but I'm sure it would be at the lower end of the scale.

I really appreciate your help so far, and I'm sorry to keep harping on about this, but there is this one point that I really struggle to get my head around.

I understand that my contributions to my pension are offset against my income and therefore I save the IRPF (income tax) on those contributions. For arguments sake, let's say that amount is 18%.

When I turn 65 I will take my money out as a lump sum. 40% of that is tax free (as you advised me earlier). The remaining 60% will be taxed at the applicable IRPF rate for that year. If we factor the lump sum into my earnings for that year, my income will be very high and I would enter the highest tax rate, which I understand to be something like 43%. Therefore I will lose almost half of the taxable part of my pension to the Hacienda.

So here is where my head goes around in circles. Why would anyone pay into a pension plan if they are saving on income tax at only 18% now, but further down the line have to pay 43% income tax on the bulk of the fund?

I'm sure I'm not understanding this correctly. Sorry I'm so pesada!

poshnbucks

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To get your heart racing.........getit..........here's a pic.

Fred James

Pension plans are primarily designed to give you a pension after retirement - they are not a savings vehicle for a lump sum although there is usually that option which is potentially taxable.

If you put the whole of the proceeds into an annuity it has very significant tax implications.

The good news is that the annuity income is treated as part return of capital and part interest. As a result the Spanish taxman allows payment of part of the annuity completely free of tax. The percentage depends on your age when you first take income from the annuity but if you take it at age 60 then only 24% is taxable. Further good news is that annuity income is now classed in the same way as savings income and is taxed at a flat rate of only 18% irrespective of total income.

Compared to the tax situation in the UK this is a seriously good deal. You get up to 43% tax relief when you contribute from your earnings and end up paying less than 5% tax on the proceeds (that's 24% of 18%)

The key point about the pension plan is that it must enable YOU to make the decision as to what to do with the money. An employer's pension scheme which just pays you a pension would not qualify.

The Spanish term for these annuities is "Rentas Vitalicias" and currently over 2 million Spaniards have them - with the tax benefits that they give that's not surprising!

Incidentally these rules also apply to resident ex-pats who have a similar UK annuity - I know - I've got one!

To put it into perspective, taking into account personal allowances, I can earn as much as 35000 euros from my annuity without paying ANY tax.

iant

Important correction to my previous posts. As a result of the latest modifications to the tax law, contributions made to pension plans as from 1/1/07 will NOT be eligible for the 40% exemption if taken out in lump sum. This changes significantly the situation and means that the annuity approach is normally much more interesting.

Remaining advantages are the reduction in taxable income in the year contributions are made, use of the cash saved until plan is terminated, and "repayment" of the tax deferred at normally lower levels of taxable income once retired.

Apologies for my incomplete prior information.

iant

Veleta

Ok, so let's see if i am beginning to get this now.

I would be foolish to take my pension as a lump sum when I retire because the whole amount would be taxable at the highest IRPF rate (assuming there is a decent amount of money in the fund). That would be 43%ish, almost half of the fund would be lost to the taxman.

Taking it as an annuity is the right way to go. Only 24% (depending on age) would be taxable at the low rate of 18%.

Now this leads me on to my next question.....

I understand that I have to choose over what term my pension is paid out...5 years, 10years, 20 years, etc.

Does this have any implications on the amount of tax I would have to pay??

BTW - all of this advice is much appreciated. I took out the pension plan a few years ago because, y'know, I figured that has to be a good thing to do....right? But I really had no understanding of the mechanics of it at all.

Fred James

This sounds like a different form of pension where the payments are not for life as in an annuity.

I have no personal experience of this type of pension so can only guess at the tax implications. From what I can see in the tax manual this is a "temporary" income and is taxed at different rates according to the period of payout. The shorter the period, the smaller % that is taxed.

This is logical as if you pay out over 5 years most of the income will be repayment of capital rather than accrued interest. The figure suggest a range of 4 bands with the taxable amount varying from 12 - 25%.

I think you need to establish exactly what type of pension you have and take some professional advice as to how it will be taxed and whether you have any other options on maturity such as transfer into an annuity.