Pensions…why do I need to bother?
The only people who don’t have to worry about retirement planning are those that are so rich that money will never be a problem. For the rest of us, pension planning should be a top priority. It doesn’t matter if you haven’t bought your own home or invested a cent of your own money yet, provided you have a good pension plan in place.
Thanks to longer life expectancy people will spend anything from 20 to 40 years in retirement. Each person should be reducing their income now when earnings are high and putting this money into a pension scheme as it is likely that once we retire our income will fall, but this type of planning will make the transition less of a shock.
Life expectancy levels are increasing. On average people live to 80 years of age with women living five or six years longer than men. If you expect to retire at 65, how will you finance this 15 years? The State Pension age is also being pushed out to 68 in 2028 so you will have to be prepared to work for longer to receive this. That is assuming the payment will be sufficient to meet your needs. Women, who have a longer life expectancy then men, tend to be worse when it comes to retirement planning with many admitting they do not know how they are going to fund their retirement.
What should I be doing?
Are you reviewing your company pension scheme annually? Will it be sufficient for retirement?
A growing number of schemes are producing disappointing returns and will not ensure a comfortable old-age income. You should not be complacent; schedule an annual review to assess the adequacy of your existing pension arrangements. In my own experience most people do not engage in pension planning until they are close to retirement age. The later you leave it the more income you will have to devote to building up a decent pension, so begin today.
The self-employed in particular should engage in pension planning as soon as possible. People who continue to ignore the risks could face an impoverished retirement.
You should always deal with someone who is independent, and authorised to tell you about every single option available to you. Pension fund performance and management fees vary enormously.
What about the state pension?
The state pension in unlikely to provide you with a sufficient pension on retirement. Take control of your financial future, even if you are fortunate enough to have employers that make contributions on your behalf. Constant monitoring of that provision is needed to ensure it will be adequate for your own financial needs on retirement.
Making provision for retirement should be done as tax-efficiently as possible.
When should I start making contributions?
Ideally you would start making pension contributions at least 30 years before retirement age.
So how much money will I need?
First it is important to decide your expected retirement age. Hopefully your mortgage will be paid off by that time and your children will no longer be dependent on you.
Once these items have been removed decide what level of yearly income you will need in retirement. You should then multiply this figure by 25 to 30 times to calculate the retirement capital you will need. Therefore if you wish to have an income of €30,000 a year it is likely you will need retirement capital in the region of €750,000 to €900,000. This assumes your spouse has made his own provision for retirement and will not be dependent on you.
Many people will wish to invest in property or stocks as part of their retirement planning, however saving through pension plans is for most people the more attractive option due to the tax relief available.
What are the tax incentives available?
- Tax relief on personal contributions
- Tax-exempt investment growth within the pension investment
- No tax liability on employer contributions to pensions.
At a very basic level if you are a higher rate taxpayer for every €100 you contribute you will get €40 income tax relief, so if you invest €100 the actual cost to you is only €60. If you pay tax at the 20% rate you will pay €20 less in income tax therefore for €100 contributed the actual cost to you is only €80. The maximum amount of pension contributions on which you can claim tax relief is capped. This cap is based on your net relevant earnings and your current age.
For some specific occupations such as certain professional sports players, the 30% limit applies irrespective of their age.
It is worth noting that net relevant earnings for a husband and wife cannot be aggregated for the purposes of retirement savings purposes. Also investment income or rental income are not treated as relevant earnings and cannot be taken into consideration in calculating your maximum allowable pension contributions.
The Benefits of Pensions
The fact that pension funds can grow without any liability to Income Tax on investment income, and without any capital gains tax on fund growth makes them a unique way of investing.
All individuals who fund for retirement through a pension plan are entitled to take a lump sum at retirement. Also for employees, there is no liability to income tax, PRSI or USC on the contributions their employers make to occupational pension schemes on their behalf, assuming these are within the relevant limits.
For individuals who own their own limited companies having the company contribute to an occupational pension scheme is an excellent way for them to extract profits from the company tax efficiently. Their spouses may also be employees of the company and their retirement can be funded through an occupational pension plan also.
In order to deter abuse of the rules regarding tax incentives offered there is a maximum limit on the value of the accumulated pension fund. This limit is the standard fund threshold (SFT) and is €2million from 1 January 2014.
What Are AVCs?
These are additional voluntary contributions which employees and directors who are members of occupational pension schemes can invest in order to enhance the value of their scheme. It is important to note the Revenue limits before making AVCs.
AVCs are often used to help employees retire early from employment. The usual rules regarding tax relief apply, and the scheme members’ total contributions including AVCs are subject to the age-related limits. Back-dating of tax relief on lump sum contributions not made by salary deduction to the previous year is allowed.
Lines such as “past performance is not a reliable guide to future performance” you may be familiar with. However this is true?
You should engage the services of a financial adviser that will assess your risk levels and a pension investment strategy should be suitably designed. Typically a pension fund will hold a wide range of assets and even a fund that is invested in one asset class, such as bonds, will hold a large number of different types of bonds.
The most important thing is to remove your head from the sand when it comes to retirement planning and to start early. Book an appointment with a financial adviser, identify how much you can save monthly and start your retirement planning today.
For further information email Caroline’s Email