Why do we penalise Irish people for using index funds?
Here’s a copy of an email I’ve sent to my local TDs in Ireland:
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Hello ,
I’m Ronan – an entrepreneur living in Blackrock. I grew up in Newbridge, went to UCD, and then went over to MIT where I did a PhD and ran a startup that I sold in 2020. Since then I’ve moved back to Ireland and am working on another startup.
Since my startup is new and we aren’t profitable yet, I pay myself very little salary. Although I have made good money from my first startup, this means I don’t have a way to avail of a pension scheme for my savings.
My plan was to set money aside in index funds (a diversified way of investing that is common in the US, and in Irish pension funds). However, I learned that index funds (outside of retirement schemes) are subject to :
1. Deemed liquidation after 8 years.
2. Taxation as income (at 41%) on capital gains (rather than at the normal capital gains rate of 33%).
Said differently:
– If I invest directly in a stock (e.g. Apple or Berkshire), then there is no deemed liquidation after 8 years, and I pay the 33% capital gains rate when I sell, but,
– If I invest in an index fund to get diversification then I have forced/deemed liquidation every 8 years and pay higher tax.
I don’t know exactly what motivated this rule. I can see how funds might take advantage to recycle dividends into new investments without paying tax on those dividends. However, most index funds don’t recycle dividends, they pay them out and they are taxable as normal income. So, the law as it stands is basically pushing Irish people to not have their savings in index funds and instead buy individual stocks or, probably property (another contributor to housing inflation).
A cynical take here – perhaps unfair – is that the current rules highly favour the Irish pension advisory funds because this incentivises people to put as much money as possible in pension schemes (not possible in my case as I haven’t enough salary to be eligible for much). Irish pension funds charge 1-1.5% per year, whereas these index funds often are charging less than 0.1% per year. Since using cheap index funds is highly penalised by the tax code, it’s still better to use the expensive pension schemes (if you can).
Can you draft a bill to remove this tax treatment from index funds? If there is concern around custom funds taking advantage then you could optionally ensure that:
a. This treatment is limited to market cap weighted funds.
b. Dividends must be distributed (and taxed as normal income) [which is the case for all of the major index funds].
Doing this will remove a big disadvantage for Irish people that limits them from holding diversified index fund investments.
And maybe I’m missing something here about why this rule is in place, and I’d appreciate any insights you have to share on that.
I’ve also written to other TDs in my constituency asking the same, cheers, Ronan