The mycash.ie quick guide to pensions

The current old age pension is €206 per week. Not many of us would be happy to live on that sum in our retirement. Yet, in spite of all the advice and urging of government and commentators, Irish people have shown themselves to be rather resistant to the charms of pensions. Mycash.ie aims to change that by showing you just why investing in a pension is the soundest financial decision you can make. Read on to find out why this is so; alternatively, go directly to the mycash.ie Defined Contribution pension simulator.

Pensions – the benefits

Investing for your retirement makes sense in its own right but the related tax advantages make pensions a terrific prospect

You get tax relief on your contributions

Subject to a maximum contribution (discussed below), you get full tax relief on all of your pension contributions. The effect of this, particularly if you are paying tax at the highest marginal rate, is dramatic. There is no comparable investment product that can give you this level of return.

Let’s imagine you have €590 to invest in your pension at the end of each month and you are paying tax at a marginal rate of 41%. The pension tax break means that the Revenue will effectively add €410 to your €590, giving you €1,000 invested in your fund each month. This makes an incredible difference over the long term: let’s compare a regular investment of €590 with €1,000 over 30 years at a growth rate of 4% net of fees.

Investment growth is tax-free

Regular investments and deposits are subject to DIRT at 23 %. Pensions are not. This has a big effect on your fund over the long term.

You get a tax-free lump sum when you retire.

With a pension, you can take 25% of the total value of your fund tax-free on reaching retirement. Let’s say your fund is valued at €1 million on retirement. This means your tax-free sum is €250,000. If you pay tax at 41% you would have to earn €423,729 gross to realise that amount, a tax saving of €173,729.

 

Your contributions

The extent of tax benefits on pensions mean that for a person who has the disposable income and hasn’t yet taken out a pension, the only question should be – “how much can I invest?” The answer is “as much as you can afford” but there are limits on how much you can invest tax-free. This depends first on your age:

                                    Age                  % of income
                                    Under 30             15%
                                    30-39                  20%
                                    40-49                  25%
                                    50-54                  30%       
                                    55-59                  35%
                                    60+                     40%

There is also an upper limit on salary. The maximum salary that qualifies for tax-free contributions is €254,000. In other words, if you earn €300,000 and you are aged 48, the maximum contribution that qualifies for a tax break is 25% of €254,000 or €63,500.

 

How pensions work

Pensions are managed by life insurance companies and other investment firms. Your contributions are put in a fund that invests in a combination of assets such as shares (equities), property, bonds and cash. The value of your pension fund rises and falls depending on the investment performance of the underlying assets. A pension is a long-term investment: you are not allowed take it out before you retire. So, while the value of the fund will fluctuate during the term of the investment, the fund should appreciate significantly over the longer term. As of late-2007, the average managed fund had shown 11% annual growth over the past 10 years.

(Get more on how investment products work.)

Of course, the earlier you start your pension, the greater your fund will appreciate, and the more you will have to live on for your retirement. Let’s take an example: Peter started his contributions (€1,000 per month including revenue contribution) aged 30. Paul made exactly the same contribution but started when he was aged 40. Both funds grew at 4% net of fees but the difference in fund size at retirement was large to say the least when they both retired aged 65.

So, the message is that it’s best to start your pension early. Indeed, there is a rule of thumb that says that the average fund doubles every five years.

What type of pension?

The type of pension you need depends on your circumstances:

If you are an employee and already in a company pension scheme you may be happy with this arrangement. However, you may have joined the company scheme later in life and wish to boost the contribution being made on your behalf by your company. In this case you can make what is known as an Additional Voluntary Contribution or AVC.

For example, let’s say you are aged 41 and your company is contributing 10% of your salary to the scheme. At your age you would be able to contribute up to 25% of salary to your pension so you might wish to consider an AVC to make up the difference.
 
If you are an employee and have no company pension, or if you are self-employed, then you seriously need to consider a personal pension plan or a PRSA (personal retirement savings account – a type of personal pension plan that must be offered by your employer under certain conditions). A personal pension plan is a private scheme so it is you who needs to take the initiative: that means choosing a provider and product, paying the contributions and arranging tax relief.  

If you are a company director you can choose to set up an executive-style pension. These pensions are modelled on a company-type arrangement and allows you to take money out of your company without paying tax. Once you invest this money in a pension fund your benefit will be based on your final salary.

If you don’t want to invest in a standard fund but wish to choose the fund assets yourself, you can invest in a self-administered pension fund.

 

Types of pension plan

A Defined Benefit plan is typically offered by employers. It guarantees a certain percentage of your final salary when you retire, usually depending on your length of service.

Unless you are employed, you will depend on a Defined Contribution scheme. This does not guarantee a percentage of your salary. Instead, your pension income will depend on the value of your fund when you retire. In turn, the value of your fund will depend on the investment performance of the fund, the amount of your contributions and the level of fees and charges made against the fund.

The mycash.ie Defined Contribution simulator allows you to estimate your fund size at retirement based on a number of assumptions. You can change these assumptions – fund performance, level of contributions, fees etc. – in order to estimate how much you should be contributing to your pension.

Fees and charges

Pensions are a terrific investment but the level of fees and charges you pay can eat into your fund over time. Pension providers and brokers levy a range of charges on pension products including commissions, fund entry charges and yearly management fees.

The difference between two funds with similar performance but different levels of charges can be dramatic. Take Peter and Paul; they are both contributing €1,000 per month and each fund is giving a 5% return. Peter, however, is being charged an initial commission of 10% of the first year premium plus a 5% annual management charge.  The difference in the final fund is dramatic.

Mycash.ie has a totally transparent, commission-free policy that ensures your fund is fully invested saving you thousands of euro over the lifetime of your fund.

 

What to do with your fund

Once you have retired you can immediately take 25% of your fund tax free. You then have a number of options with the balance and these are discussed in the mycash.ie quick guide to annuities and ARFs.