When we think about our retirement provision, we usually think of building up pensions, annuities and the like.
Gross pension provisions
Pensions and annuities are gross retirement provisions. The contributions you pay into these schemes are deducted from the income on which you pay payroll tax and income tax. It is only when you receive the benefits that they are taxed.
However, tax regulations impose strict conditions on the deduction of contributions or payments. These conditions have been significantly tightened in recent years. As a result, you are able to build up much smaller gross pension provisions.
Advantages
A gross pension scheme has a number of advantages.
- You will pay income tax at a later date and possibly at a lower rate.
- The provision must be held with an authorised fund or insurer. This means you cannot spend the money set aside for your retirement on other things. You have less control over whether there will be enough in the fund at the time of payout. After all, this also depends on how the fund or insurer has managed your savings. What return has been achieved? What costs have been deducted from your savings?
- You do not pay annual income tax in Box 3 on the returns from your gross pension scheme.
- Generally speaking, a gross pension provision does not (or not entirely) need to be “used up” if you face a major setback during your lifetime. Examples of such setbacks include unemployment, incapacity for work and admission to a care home.
Net pension provisions
Due to the restrictions on the ability to accrue gross pension provisions, you are increasingly reliant on net pension provisions. These are pension provisions that are accrued from income on which you have already paid income tax. Think, for example, of a simple savings account into which you have decided to pay a monthly amount, to be withdrawn once you retire. But of course, this could also involve investments in shares, bonds and other assets.
Your own home (or other property) can also serve as a net retirement provision. To the extent that the value of your home exceeds the outstanding mortgage, you can use this amount towards your retirement provision. This amount increases as the value of your home rises and, of course, as you make repayments on the mortgage. If, on the other hand, your home falls in value, you will be drawing down on this part of your retirement provision. You must also bear in mind that you cannot eat the bricks of your home. To be able to buy bread and spreads, you will at some point have to convert those bricks into euros.
The advantages of gross pension schemes described above are, of course, the disadvantages of net pension schemes. A major advantage of net pension schemes is that you can decide for yourself how to manage them. That offers you opportunities. It gives you freedom. However, it does require (financial) discipline and a clear understanding of the risks. The government has significantly scaled back most financial safety nets in recent years. Up-to-date financial planning will provide you with the necessary insight.
A business as a retirement provision
Entrepreneurs often regard their business (in part) as their retirement provision. Insofar as the business is run as a sole trader, a partnership or a general partnership (VOF), this constitutes a net retirement provision. After all, income tax has already been paid on the profits. You can withdraw these from your business tax-free.
Insofar as your business is operated as a private limited company (or another legal entity), the savings pot is not yet entirely net. Corporation tax has indeed been paid on the profit. However, as soon as the profit is distributed, a substantial interest tax is still payable.
Subject to certain conditions, you can also set up gross pension schemes within your business. However, the government is also significantly restricting these options. Very recently – as of 1 July 2017 – the option to accrue a pension under your own management was introduced completely abolished.
In contrast, when it comes to the self-employed, there is talk of creating opportunities for them to build up a pension.
Insurance
A form of net retirement provision that was popular in the past is endowment insurance. Under this scheme, savings are accumulated towards a lump-sum payment, which is paid out in a single instalment upon maturity. Endowment insurance was often taken out in conjunction with financing a home. You had to pay the premium for such a policy out of your net income. However, provided you remained within the terms and conditions, the return achieved on the policy was tax-free. This tax-efficient way of saving has, however, been abolished for some time now. The options for surrendering existing endowment policies have been expanded with effect from 2017 (see our article Surrendering a home equity insurance policy).
New endowment policies are taxed under Box 3. As a result, the popularity of endowment policies as a savings product has fallen to virtually zero.
Term life insurance policies are still quite common. With a term life insurance policy, you do not build up any capital. The policy pays out only if the insured person dies during the term of the policy.