John Lowe of Money Doctors.ie asks when is it too early to think about retirement planning? If you are one of the 200,000 employees lucky enough to have a defined benefit scheme or one of the 700,000 + contributing to a defined contribution scheme, will it also be enough to fund your pension when you are ready to retire?
Rudyard Kipling once said words are the most powerful drug in the world and if that is the case, then pension language and literature for some must be the sleeping pills of the English language.
However, your pension is one of the most important financial undertakings in your life and it's really important to at least understand the basics.
We enjoy, without question, the most beautiful pension system in the world and yet what do most people do? Ignore it. This was so apparent nearly 20 years ago when the Personal Retirement Savings Accounts (PRSAs - have limits to the annual management fee that can be charged - 1% - and commissions chargeable - 5% - and are also portable in that you can bring it with you when changing jobs.) came out in 2002 around the same time as the Special Savings Incentive Accounts (SSIAs) where for every € 4 saved, the government gave € 1 – 20%.
A resounding 1.2million Irish people flocked to open their SSIAs while by and large giving the thumbs down on the PRSAs.
The ambivalence continues today in over half the working population. 57.6% of the working population have nothing to look forward to when they retire other than the State Pension... and there is a good chance it will have been abolished by that time!
Pensions made simple
There are currently over 677,000 Irish citizens over the age of 66 and by the year 2050, there will be 1.8million citizens over this age - 767,300 by 2026, meaning that 5 years from now more than 16% of the population will be in retirement. In 2019, for every person who retired, there were 5 workers. In 2051, for every retired person there will only be 2.
Will the government of that day have enough exchequer funds to pay the € 248.30 per week or whatever it will be then, to every pensioner in 2051?
If you are happy to live on that current State pension and you believe it will be there when you retire, then do nothing. But you cannot discount the notion that frankly by the time you retire, there may no government money to pay you.
The UK’s National Health Service recently published a report stating among other things that by 2030 the life expectancy of men will be 85.7 years of age and 87.6 for women. Funding a pension that has to last a minimum 20 years after retirement takes planning, serious planning. We are all living longer and healthier lives, pandemics aside.
Even if you are only on the lower rate of tax (20%) it still makes sense to invest in a pension and here are three reasons why a pension is still "beautiful"
- For every €100 invested, it is only costing you €80 – meaning that the fund would have to drop by 20% before you actually start losing money. On the higher rate of tax, it makes even more sense and though there are signs of the relief being reduced over the coming years, even at the 20% rate it makes sense.
- All growth in the fund is tax free.
- When you retire, 25% of this fund can be taken by way of a tax free lump sum up to a maximum of € 200,000. If you are fortunate enough to have a fund up to € 2million (the maximum allowable) you can take another €300,000 at the 20% tax rate.
All companies are now obliged to both nominate an insurance company for pension contributions and have a facility to make deductions for such contributions directly from your salary. There is a €15,000 potential fine for the company if no nomination.
Current government thinking may see employers being forced into auto-enrolment - it’s on the agenda for 2023 - potentially making a minimum 4% contribution to employee pensions with employees forced into 2% contributions for an initial minimum period.
This is a far cry from the permitted age thresholds:
Up to 29 years of age 15% of net relevant earnings
30 up to 39 years of age 20% of net relevant earnings
40 up to 49 years of age 25% of net relevant earnings
50 years plus 30% of net relevant earnings
55 years plus 35% of net relevant earnings
Over 60 years 40% of net relevant earnings
Remember too that inflation should be factored into your contributions as over time it decreases purchasing power and erodes real savings and investment returns. Since 1925 inflation has averaged c. 4% per annum so that if for instance you now need € 50,000 to fund your annual expenditure in retirement, you will need € 115,000 in 20 years’ time and € 175,000 in 30 years’ time.
If you are thinking of setting up a pension plan, there are also four main components that should be considered:
1. The strength of the insurance company where the pension fund is based.
2. The performance of both that company and the specific fund or funds where the pension contributions are maintained – with so much fund choice the vast majority of pension investors stick to the simple 5 fund managed fund structures that the leading insurance companies now offer ranging from cautious to high risk categories.
It is important to have your own risk category determined – some just go with the Lifestyle option ..the younger you are the higher the risk, the older the more cautious the fund. It is so important to review performance annually.
One major aid for investment selection is ESMA - the European Securities and Markets Authority is a body that defines the risk category for every stock on its database and also controls the European Rating Platform (ERP) which provides access to free, up-to-date information on credit ratings and rating outlooks of all public companies.
So for instance, if there are 5 "lanes" of differing risk categories, each public company has been rated and categorised for the "lane" designated by ESMA. Generally the highest risk category would include emerging markets, technology and energy stocks, BRIC countries (Brazil Russia India & China), etc. while the lowest would include cash funds and government bonds.
So all you have to do is stick to your lane rather than individualise your stock selection.
3. The annual management charges associated with the pension fund by the insurance company
4. The commissions or fees payable to the intermediary / broker who sets up the pension plan.
Stick with me – part 2 next week is even better…