With the deadline for pensions for the self-employed coming up next month, John Lowe the Money Doctor explains why the humble pension is probably the best investment in Ireland at the moment.
Like many, I have been a spendthrift, and I regret that, so it is time to sit up and take stock. We in Ireland are on a pension timebomb and several times over the past few years, politicians have tried to address the issues but spectacularly failed.
Here are 10 salient points on the topic:
1. The background to the problem
Currently, there are 677,000 pensioners over the age of 66 drawing €238.30 per week through the State Pension. For every person who retired five years ago, there were six workers – by 2050, there will only be two workers, but our aging population will have grown to 1.8 million by then.
Government payments at that time to these pensioners will be unsustainable unless something is done now to address the problem. While there are rumours, there are currently no plans to raise the pension age beyond 68 here in Ireland but it is interesting that Germany has announced they are considering raising their retirement age to 69 by the year 2060.
According to recent research, by the year 2030 the average life expectancy of men will be 85.7 years and 87.6 years for women. So, your time spent living on this planet may be much longer than you realise. Prepare to live a long time and make sure you have enough money to maintain your lifestyle as these retirement savings will need to last.
2. Who is affected?
Every individual has to take responsibility for their pension planning and not rely on others to do it for them. You are never too young to start a pension – the younger the better.
Granted, a lot of people will benefit from a pension arranged in conjunction with their employers, as employers now must nominate an insurance company as a Pension provider so that employees can have deductions made directly from their salaries should the employee wish to contribute to a pension plan. Failure to nominate by the employer can result in a fine of up to €15,000.
Other employees have already taken responsibility themselves and started private pension plans while others will use alternative investments to fund their retirement. However, there is still a significant percentage of the working population who for whatever reason have decided to ignore this problem. In fact, close on 50% of the working population currently have no pension plan in place at all.
3. Why a pension?
When you stop working financially, you will need an income from some other source to continue living. While some of your monthly costs may be less when you are retired, you will still have sizeable expenses especially if you wish to fulfill life dreams and bucket lists. A pension is a savings plan withdrawable on retirement which attracts three specific tax breaks:
- Tax-relief on the contribution that you make to your pension at your marginal rate of tax
- Tax-free growth in the pension fund
- The availability of a tax-free lump sum from the pension fund at retirement age of up to 25% of the fund to a maximum of € 200,000. If YOUR 25% is larger than € 200,000 the balance can be taken at 20% tax rate.
4. What's the first step?
Do an annual budget. Ask yourself if you retired, could you live on €233.30 per week? However, the question you must answer is can you afford to make any pension contributions at all? Ideally, you should be maximising that tax relief.
Age % of Income that can be contributed to your pension
20 – 29 15%
30 – 39 20%
40 – 49 25%
50 – 54 30%
55 – 59 35%
5. Pension options
The type of pension you start is determined by your employment status:
A Company Director can start an Executive Pension Plan or a Small Self Administered Pension - SSAPs ( another name is the Self Directed Trust )
An employee in a company that has a pension provision will be a member of a Company or Group Pension. This is also called an Occupational Pension Plan. He/she can also make additional contributions to the pension plan by way of an Additional Voluntary Contribution - AVCs
An employee who works for a company but does not have a pension arrangement can start a Personal Pension Plan, a Personal Retirement Savings Account (PRSA).
A Self Employed Individual can start a Personal Pension Plan, a Personal Retirement Savings Account (PRSA) or a Self Invested Personal Pension.
An Unemployed Individual or a Homemaker can start a Personal Retirement Savings Account (PRSA). However, as they may have no taxable income, they cannot claim tax relief on the monthly contributions.
The one word for all the above is START.
6. What should we do now once the pension plan is in place?
You can work out with your adviser the amount of money on a monthly basis you will need to keep you in the luxury you have become accustomed to when you retire. This will include inflation, your attitude to risk and your primary retirement objective – e.g. do you have any desire to leave assets behind and merely wish to have enough income to see out your days? You will also need to have an investment strategy put in place. Your fund needs to grow.
7. Review and review
It is really important that you review your pension on a regular basis i.e. at least once a year. The size of your pension fund is driven by a number of factors – the performance of the assets your pension is invested in, fees and charges, the contributions that you make and the length of time between starting the pension and retirement age.
Most pensions are invested in a mixture of Shares, Property, Bonds and Cash. Fortunately, over the last 7 years, other than cash, these asset classes have grown handsomely all but the last stagnant 9 months or so. But just like 9 years ago, we could experience another "correction" – the next Bear market.
For an individual with over 10 years to retirement age, this should not be an issue. However, for those people who are closer to retirement age, there could be a detrimental effect on the final income that they will receive at retirement due to timing. Therefore, it is crucial to review your pension every year.
8. I'm sorted – my employer is contributing
Having an employer make a contribution to your pension is very advantageous for two reasons:
- The contribution that your employer makes is not taxable either as an income or a Benefit in Kind
- It increases the overall contribution that goes into your pension fund
However, many people are lulled into a false sense of security because they are in an employer sponsored pension. They believe that this pension is somehow guaranteed and that it does not need to be reviewed, whether a Defined Benefit Pension or a Defined Contribution Pension. Many also believe 5% contribution from the employer along with their own 5% will suffice for their future retirement income. Try living off 10% now!
If you are in an employer sponsored pension, you should still review this pension on a regular basis as well. From 2022, employers will be forced to commence and pay into their employees’ pensions.
9. Obtaining independent advice
When you meet an adviser for the first time, you should be given a Terms of Business. This will tell you what insurance and investment agencies the adviser maintains plus how the adviser earns their fees. Most firms are paid by the insurance companies. It is important therefore for you to know the remuneration the adviser earns from doing business with you.
10. The 48 hour rule…
For most people, apathy ignorance and lack of time are the three killjoys when it comes to making decisions on pensions and most things financial. Another factor is the 48-hour rule. Attending a seminar or reading an article such as this is a complete waste of time if firstly this is relevant to you and secondly you then do not act on it within 48 hours. After 48 hours, you have other things on your mind…
Save now before it is too late.