At the start of a new year and as outlined in our other article this month, we all tend to take stock of how we manage our finances. We look at our financial habits, ways of saving money and managing our spending better. This is also a great time of year to take a hard look at our retirement planning, to ensure it is in the best shape possible.
Here goes on five reasons why we think it’s a good time now to do so.
The State Pension picture is far from rosy
Where do we start on this one! There is a lot of uncertainty over the long term viability of the state pension due to the fact that the ratio of people working compared to retired people is reducing from 5 to 1 today, to 2 working to 1 retired by 2050. As the numbers of those working reduces in relation to the numbers of pensioners receiving benefits, there will be less money coming in to the central government coffers, with more going out. Who is going to pay for the benefits, as the government actually hasn’t saved any money for future pensions?
In any event you can’t rely on the state if you want any more than a subsistence lifestyle. The maximum state (contributory) pension is currently €243.30 per week for a single person and €442.30 per week for a couple. While this will increase marginally from March 2019 as announced in the most recent budget, it's not a lot of money if you fancy going on the odd holiday!
The state is looking to address this problem – we’ve already seen retirement dates and eligibility for state pensions pushed out. For anyone born in 1961 or later, they won't get their state pension until age 68. We’re likely to see further such developments in the future. Could we possibly see retirement ages being pushed out further again, benefits being reduced / means tested or stricter qualifying conditions? Nothing can be ruled out.
The government has recently announced a move towards mandatory pensions to also help address the situation, so watch this space… The reality is that it’s up to each of us individually to look after our own retirement needs, if we want a nice lifestyle to enjoy later in life.
We’re all living longer now and can thank our healthier lifestyles, better diets and medical science for this! While this is certainly good news, it also comes with a price. If you live longer, you need a bigger nest egg to see you through these years. Savings in retirement will need to last on average for at least 20 years in retirement for female clients who are aged 66 and 17 years for males when they retire, based on current mortality rates. Indeed more and more people will now be retired for 30 - 35 years. What size of pension fund would you need to maintain your lifestyle for that period? Many people seriously under-estimate the size of their required fund to maintain a chosen lifestyle over such a long period of time.
It’s time to take Control
Well it’s probably quite obvious but the longer that you pay into a pension fund, the more you can expect to receive when you retire and the more likely you are to achieve your financial goals. Be realistic about how much it will take to achieve your goals. As a very rough rule of thumb, you should aim to save “half your age”. So if you are 40 years old, you should aim to save 20% of your income each year from now until retirement to build up a decent fund. If you wait until you are aged 50 to start, you should then aim to save 25% of your income each year.
Of course, this is only a rough calculation. We will help you develop a far more tailored picture for you, taking account of any existing benefits that you have already built up, and will help you to implement a plan that is right for your particular circumstances.
Compound interest is your friend
The “Rule of 72” is a simple maths equation to determine how long an investment will take to double, given a fixed annual rate of interest. All that you have to do is divide 72 by the expected rate of return. The answer is the number of years it will take for the amount of money to double.
- If you are aiming for a return of (say) 8% p.a., it will take 9 years for your investment to double (72/8% = 9 years)
- However if you are more cautious, you may only be aiming for a return of (say) 3% p.a. In this case it will take 24 years for your investment to double (72/3% = 24 years).
So starting early, having the opportunity to take on a bit more risk in the hope of achieving higher returns and then having the benefit of time can have a seriously positive impact on your pension fund. It really is a case of starting sooner rather than later.
Then there’s the question of how to achieve higher growth rates. First of all, a long-term perspective is critical, particularly if you are investing in the likes of stock markets. For example, according to historical records, the average annual return for the S&P 500 since its inception in 1928 to 2017 is approximately 10% p.a. Now there have been a number of crashes along the way and of course previous returns are not a guide to future performance, but they give a sense of what can be achieved over a long timeframe when one is willing to accept a level of risk.
And then there’s the Tax Benefits
Clients who are paying income tax at the higher rate of 40%, effectively receive a 66% increase on their pension contribution when investing, i.e. by foregoing €6,000 in net pay, €10,000 is invested in your pension. Pensions are pretty much the final frontier for such generous tax reliefs. Also any contributions paid before 31 October next can be used to reduce your 2018 tax bill. This applies to contributions to personal pension plans (e.g. PRSAs, Retirement Annuity Contracts) and employment pension schemes (i.e. AVCs – Additional Voluntary Contributions).
In addition to tax relief on contributions and your fund growing free of any tax (DIRT, CGT etc.), clients can also avail of a tax free retirement lump sum up to €200K. In most circumstances, a structure (Approved Retirement Fund – ARF) can also be put in place at retirement that enables tax efficient wealth transfer on death to your estate of any remaining fund.
Payments by a company into a directors or employees pension can be even more attractive. We would be happy to talk through the best options available to you.
There’s 5 good reasons to review your pension now. Please give us a call and let us help you achieve the lifestyle that you want in retirement.