When thinking about this question, there are a few simple questions you need to ask yourself…
Could I live on €12,651 a year?
Do I like paying tax?
Am I comfortable with bank savings interest of 0.5% (source Irishdeposits.ie 8/2/18 on an 18m fixed account)?
You might have several different conversation with various people about pensions and hear several different opinions on them. The classic reaction in Ireland to pensions is that they’re either too complicated, people don’t understand them, or that they’re a dangerous way to use your money. All of these are based on people’s experiences with pensions but they are misconceptions.
It’s a lack of understanding of pensions that has led them to have negative opinions on what they are and how they work. My job as an advisor is to educate my clients and put their mind at ease.
The current situation in Ireland is that there’s a dramatic shortfall in private pension funding for the general PAYE worker. As of October 2015, only 46.7% of Irish workers were members of any sort of pension in Ireland (CSO). In 2009 it was 51.2%. So we’re actually getting worse. This means then when it comes to retirement, 53.3% of Irish workers are relying solely on the state pension of €12,651 per annum (from March 2018 for single person with no dependants). Which is a dramatic drop from the average Irish full time wage of €45,075 (CSO).
Going back to one of my questions, do you think you could maintain your current lifestyle with a drop of earnings of almost 72%?
Now, agreed, we don’t need as much income in retirement as we do in our working lives. Kids are reared, mortgages are paid off, and shopping bills are lower. But even if you cut your annual earnings in half, you’re still a long way off with only €243 a week to work with.
So that’s the first reason why they make sense, we simply can’t rely on the state pension alone. But that’s one of many. The second question above is if you like paying tax. Pension are the most tax efficient way for you to provide this replacement income. The three main tax incentives are the relief on the way in, the tax free growth, and then the tax free lump sum.
When you pay in, either 20% or 40% is refunded to you on each of your personal contributions depending on your current rate of income tax. In effect, that means that if you’re at the higher rate, and you pay €200 per month to a pension, the actual cost to you is only €120. However, ensuring every cent of any premiums you pay into a pension have to be invested. A good advisor will ensure that you aren’t paying unnecessary upfront charges.
The money in the pension grows tax free. If you were to put you money in a bank, or a stocks and shares, you will pay tax on ever euro that it grows by. This tax will either be DIRT at 37%, Exit Tax at 41%, or Capital Gains at 33%. Pensions are totally tax sheltered. If your money sits there for 30 years and grows by 5% every year and compounds up, you will benefit from every % of that growth. If you compare €100 a month going into a pension account, versus €100 going into a bank account, over 30 years, taxing the tax relief into account, the pension will grow to €93,000 whereas your bank account will make it as high as €45,000.
Lastly, you will get a lump sum of 25% of your total pension as a tax free cash in hand lump sum on the day you retire. The balance is then either placed in an account for you to draw out money as you need it over your retirement, or used to provide a permanent income for you for life. Which option is best for you also requires professional advice.
The difference in pension growth over a bank account mainly comes down to the tax environment. But the pension investment has a key role. And pension investment is also a major fear of people. However, pension investment doesn’t need to be a scary thing. The way in which they’re invested falls very much in line with what you want or expect. The charges for any investment are also fundamental in making sure the pension is structured appropriately to you. Don’t forget, with interest rates as low as they are with Irish banks, 0.5%. You won’t beat the charges if you won’t look at alternative options.
Many Irish consumers have a pension pot from over the years whereby they aren’t sure why they are or how they’re structured. They either don’t have the time or the experience to locate and research their pensions. This can be done for them.
The pension landscape in Ireland is going to change. The government is planning on introducing a pension’s auto enrolment scheme for workers who aren’t members of a private pension. But how much they will make you pay and how it and who will manage and administer this for these PAYE workers is still very much in the air.
So changes are on the way, but is it enough? Workers in Ireland need to educate themselves as to what pensions are, how the work and learn how by having a private pension can be one of the smartest financial decisions they can make. A Qualified professional pension advisors can guide people through each of the steps, and help answer some of the important questions.