Mention the word 'pension' to most people and the eyes start to glaze over.
The sad reality is we are demographically an ever increasing ageing population – 680,000 over the age of 66 currently but 1.8million over this age in less than 28 years' time! Our birth rates and immigration factors are also not conducive to think we can support this ageing population in 28 years’ time.
Hence a little too late, auto-enrolment is finally being introduced toward the end of 2023 while the current government is also thinking of incentivising those who wish to delay their pension at age 66 by a year for a 4% higher weekly payment (this means you would want to live until at least age 92 to justify this decision).
John Lowe of MoneyDoctors.ie demystifies and simplifies what you need to know with these five basic pension precepts.
1. The pension is the best investment in Ireland
If you are on 20 per cent or 40 per cent tax rate, for every €100 you invest in your pension the government give you back €20 or €40. Means you are up in your investment 20 per cent or 40 per cent before you start – obviously being on the higher tax rate makes it more advantageous.
2. The older you are the more you can contribute to your pension to maximise your tax relief.
So for example if you are between 30 and 40 years of age, you could invest up to 20 per cent of your net relevant earnings into your pension.
For example, €40,000 annual salary allows you to invest up to €8,000 per annum or €666.67 per month into a pension (unless the government introduce the much hyped 30 per cent tax band, you will be in the 40 per cent tax rate on this income) meaning that you will receive a tax credit of €3,200 annually or €266.67 per month so effectively the pension is only costing you €400 per month.
The new auto-enrolment which starts toward the end of 2023 is, as Shakespeare said, much ado about nothing… at the end of 10 years of contributions from both employer and employee plus a government contribution, you can look forward to a maximum of 14% each year invested in your pension.
A 24 year-old can invest today 15 per cent on their own income into a pension and obtain potentially 40 per cent tax relief on it instantly from year one.
3. Occupational pensions (set up by your employer) generally have a Normal Retirement Age - NRA - of 65 (or 66 in some cases and for executives age 60) while setting up your own pension will allow you to access your fund at age 60 (Personal Retirement Savings Account - PRSAs).
With the retirement age being pushed out to age 68 from 2039 – only 17 years away, it means MOST tax payers will need to maintain employment til that age when the State Pension kicks in, currently €253.30 per week. Don’t delay, invest something into a pension.
4. Working in different companies means you may have a collection of pensions that you may have to wait to access until your NRA (Normal Retirement Age).
Those companies in the interim could go out of business, declare bankruptcy or liquidate. You will also need a trustee from your former company to sign off to access your pension on retirement date. You could have a problem.
This could be resolved by simply transferring that occupational pension into a Personal Retirement Bond. This has many benefits:
- You are now in control of the pension
- You can decide where it is invested
- At age 50, irrespective of your NRA, you can commute this fund
- Take 25 per cent tax free
- Transfer the balance into an Approved Retirement Fund (ARF)
- You choose the funds (to maximise returns)
- Once aged 60, you must take out 4 per cent per annum (called imputed distributions) and on reaching age 71, increase to 5 per cent per annum.
- You can also draw down up to 15 per cent in total each year without penalty but obviously you will run out of funds much quicker…
- If you die and you have a spouse/civil partner, the balance of the ARF automatically is transferred to that person as if it is their own ARF. If both you and your partner die, it goes to your children (they pay 30 per cent in tax on the fund) or your estate if you do not have children.
It will certainly be worth your while to check out if your old pension can be transferred to a Personal Retirement Bond or Buy Out Bond.
5. "Commuting your pension"
When you reach retirement age, your pension fund becomes accessible to you. Many people are unaware of what happens next or what the best option is for them:
At retirement age your fund is say €500,000. What now?
- You can take 25 per cent tax free (€125,000)
- With the balance of €375,000, you can go two ways
· A set interest rate on the day of retirement that never changes. Current annuity rates are low (they are linked to bank interest rates) so at c. 2.5 per cent, your monthly annuity would be €781.25 per month for life…
- This is also taxable and generally only guaranteed for the first 5 years
- In the 6th year you die and the insurance company keeps the €375,000 NOT your family
2. Approved retirement fund (ARF)
· You choose WHERE you want to invest (so even in retirement you still have to manage your fund to maximise returns)
· Once aged 60, you MUST take 4 per cent annually (or in monthly payments of €1,250) called imputed distributions
· On reaching age 71, you MUST take 5 per cent annually (or monthly €1,562.50)
· You CAN take up to a maximum of 15 per cent each year without penalty but obviously reducing the fund faster and shortening the payment span.
· If you die, the balance of the fund goes to your civil partner or spouse as if it is their ARF. If you both die, the fund goes to your children, if there are children, but they pay a 30 per cent tax on the fund balance. If no children, the fund goes to your estate for distribution according to the wishes in your Will.
There, you've read through it – well done! It really is in your best interest to start thinking pensions. Give me a call if you’re worried.
The views expressed here are those of the author and do not represent or reflect the views.