John Lowe the Money Doctor asks when is it too early to think about retirement planning ? In this first part, John asks 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? They generally ignore it. This was so apparent over fifteen 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 around the same time as the Special Savings Incentive Accounts (SSIAs). 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 half the working population.
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 9 years from now more than 16% of the population will be in retirement. In 2010, for every person who retired, there were 6 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 € 238.30 per week or whatever it will be then, to every pensioner in 2051 ?
If you are happy to live on that current State pension of € 238.30 each week then do nothing. But you cannot discount the notion that frankly by the time you retire, there may not be enough government money to pay your weekly pension. 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.
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 – 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.
In part 2 next week, John goes through the various considerations when assessing pension needs. Planning is becoming such an important element and its better to do it now than procrastinate.