John Lowe of Money Doctors.ie asks when it is too early to start thinking about retirement plans. 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, then it will be enough to fund your retirement too if you are ready to move into the To retire?
Rudyard Kipling once said that words are the most potent drug in the world, and if so, then pension language and literature must be the sleeping pills of the English language for some.
However, your retirement is one of the most important financial businesses in your life and it is really important to understand at least the basics.
Without question, we enjoy the most beautiful pension system in the world and yet what do most people do? Ignore it. This was so evident almost 20 years ago when the Personal Retirement Savings Accounts (PRSAs) have limits on the annual management fee that can be charged – 1% – and commissions – 5% – and are also portable if you can bring them with you when changing jobs.) came out in 2002 around the same time as the Special Savings Incentive Accounts (SSIAs), where the government gave 1 – 20% for every € 4 saved.
1.2 million Irish flocked to open their SSIAs while, by and large, keeping their thumbs down on the PRSAs.
The ambivalence continues today in over half of the working population. 57.6% of the working population have nothing else to look forward to when they retire than the state pension … and there’s a good chance it will be abolished by then!
Pensions made easy
There are currently over 677,000 Irish citizens over 66 years old and by 2050 there will be 1.8 million citizens over 66 years old – 767,300 by 2026 which means that in 5 years’ time more than 16% of the population will be retired. In 2019 there were 5 workers for every person who retired. In 2051 there will only be 2 for each retiree.
Will the government have enough funds this day to pay the € 248.30 a week or whatever to every retiree in 2051?
If you are happy to be living on this current state pension and you believe it will be there when you retire, then do nothing. But you can’t ignore the idea that at the time of your retirement there may not be any 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 will be 85.7 years for men and 87.6 years for women. Funding a pension that must last at least 20 years after retirement requires planning and serious planning. We all live longer and healthier lives apart from pandemics.
Even if you only have the lower tax rate (20%) it still makes sense to invest in an annuity, and here are three reasons why an annuity is still “nice”.
- For every € 100 invested, it will only cost you € 80 – which means the fund would have to drop 20% before you actually start losing money. In terms of the higher tax rate, this makes even more sense, and while there are signs that the relief will be diminished in the years to come, it also makes sense at a 20% tax rate.
- The entire growth of the fund is tax-free.
- When you retire, 25% of this fund can be used as a tax-free lump sum up to a maximum of € 200,000. If you are lucky enough to have a fund of up to € 2 million (maximum allowed) you can take an additional € 300,000 at the 20% tax rate.
All companies are now required to both designate an insurance company for pension contributions and to be able to deduct these contributions directly from your salary. There is a potential fine of € 15,000 for the company if no nomination is made.
Current government considerations could result in forcing employers to automatically enroll – this is on the agenda for 2023 – and potentially contributing at least 4% to the employee’s pension, while forcing employees to contribute 2% for a minimum initial period .
This is a far cry from the acceptable age thresholds:
Up to 29 years of age 15% of the relevant net income
30 to 39 years of age 20% of the relevant net income
40 to 49 years 25% of the relevant net income
50 years plus 30% of the relevant net income
55 years plus 35% of the relevant net income
Over 60 years 40% of the relevant net income
Also, keep in mind that inflation should be included in your contributions as over time it will decrease purchasing power and undermine real savings and investment returns. Since 1925 the average inflation rate has been c. 4% per year. For example, if you need $ 50,000 now to fund your annual retirement expenses, you will need $ 115,000 in 20 years and $ 175,000 in 30 years.
Also, when considering setting up a retirement plan, there are four main components to consider:
1. The strength of the insurance company in which the pension fund is based.
2. The performance of both the company and the specific fund or funds in which the pension contributions are held – with so many funds to choose from, the vast majority of pension investors stick to the simple 5 fund-managed fund structures that leading insurance companies now use offer cautious towards high risk categories.
It is important that you set your own risk category – some simply go for the lifestyle option. The younger you are, the higher the risk, the older the fund. It’s so important to review performance annually.
ESMA – the European Securities and Markets Authority – is a body that defines the risk category for each share in its database and also controls the European Rating Platform (ERP), which provides access to free, up-to-date access Information on ratings and rating prospects for all listed companies.
For example, if there are 5 “lanes” with different risk categories, each public company has been rated and categorized for the “lane” designated by ESMA. In general, the highest risk category would include emerging markets, tech and energy stocks, BRICs (Brazil, Russia, India, and China), etc., while the lowest category would include cash funds and government bonds.
All you have to do is stay on your lane instead of individualizing your stock selections.
3. The insurance company’s annual management fees associated with the pension fund
4. The commissions or fees payable to the agent / broker who draws up the retirement plan.
Stay with me – Part 2 next week is even better …
For more information, click on John Lowe’s profile above or on his website.