No time to waste, the pensions time bomb is ticking
LAST YEAR George Lee presented a programme on RTÉ that focused on the “Pension Time Bomb”. It was dripping with ominous music and menacing pauses. Alfred Hitchcick could scarcely have made it any more unsettling.Before sitting down to watch, many of us might have been rather pleased to know that due to medical advances, a healthier lifestyle and improved road safety – to name just three key factors – we are all likely to live a lot longer than our grandparents, at least 10 years longer, in fact. The news is even better for many children born in this century as they are expected to live well into the next one (as long, that is, as they were lucky enough to be born in the developed world).
George was not, however, pleased. In fact, he seemed rather cross.
He made this increased life-expectancy seem like an out-and-out catastrophe and one that would bring the pensions industry crashing down and have us all living out our twilight years scrabbling in bins for food like cast offs from The Road. (Okay, okay we’re exaggerating a bit here, but he was still quite scary with all his talk of funds running out and governments losing the plot and the like).
While he might have scared the bejaysus out of viewers, George was on the money. We are living through the worst economic turbulence in the history of the State and hundreds of thousands of Irish people are living day-to-day and can’t even imagine putting money aside for their future. And even if they did, where would they put it, given the number of privately run pension funds that are technically insolvent?
When it comes to the State’s pensions, the scenario is arguably worse and the gap between future pension and social welfare liabilities and revenues to fund them stands at €324 billion, according to an unpublished report commissioned by the Government.
The review of the Social Insurance Fund – the pot into which about €8 billion in pay-related social insurance contributions (PRSI) go to fund a range of benefits – was commissioned by the Department of Social Protection. Last year the fund’s annual shortfall stood at €1.5 billion, or 1.1 per cent of gross national product and the study said that in the absence of policy changes, the shortfall will rise to more than 6 per cent annually by the middle of the century which will be about €324 billion in 2012 prices.
When it comes to planning for life after work, things have been made all the more difficult because of a combination of reduced salaries – thanks to pay cuts and tax hikes – and dramatic changes to the pension systems. Pension contributions are no longer deductible for PRSI purposes and they are not deductible for the universal social charge (USC), which has replaced the health levy and income levy.
But despite all the horrendous news, pensions still matter. In fact, they matter more than ever.
They are not, by any measure, sexy and talk of them will never keep people entertained at a dinner party but they are something that everyone needs to think about – except, perhaps, Lotto winners and those in the public sector who have their gilt-edged golden handshake already sewn up.
WHEN SHOULD I START SAVING FOR MY PENSION?
If you haven’t started already then start now and if you have started already start saving more. Around half the working population has a pension but most of us are not saving nearly enough.
When you are considering your pension it is important to have a target fund size in mind and aim for that with a steely resolve. “When considering pensions you need to think of a few things,” says Karl Deeter, a leading financial advisor with Irish Mortgage Brokers. “First of all you have to start early. That may seem boring but it makes a big difference.”
Deeter says for a 30-year-old who wants to fund a private pension which will return just €8,000 a year when they retire at 68, they need to make monthly contributions of about €120 – a figure which comes down due to tax relief.
“If you wait until 45 that monthly figure jumps to €285 a month. While €8,000 is not very much at all it can be used to top up the State pension which would give you €20,000 a year (in future values).”
WILL THAT BE ENOUGH?
It depends. There is not one set answer and few people seem to have a handle on just how much they need for a good retirement.
Right now the State pension pays €230.30 a week for a single person. That is just under €12,000 a year - or €6,000 less than someone gets working 40 hours a week on the minimum wage.
It is not a lot by any measure. It is important to have a realistic expectation of what you need. “Older people live cheaper due to having less debt (typically mortgage free), fewer family expenses or childcare costs,” says Deeter. “Having a paid for house as an asset can cover costs if you ever needed a nursing home or the like and while we are living longer those under age 50 will be retiring later.”
The real key is to make sure you save for the future but do your sums “and don’t try to retire too rich because, apart from sacrificing current income, you may well find that the additional gain could be swallowed up by taxation (from the pension levy to income taxes). Good old fashioned common sense is critical,” he adds.
So how much is enough? The National Pension Policy Initiative in 1998 suggested that adequate gross retirement income would be 50 per cent of gross pre-retirement income, a figure which includes the State pension. So if you earn €80,000 you need a pension income of €40,000. If €12,000 comes from the State you only need to find €28,000.
Only! To reach that magic number you will need a fund of between €700,000 and €930,000. A 35-year-old would need to put aside €1000 every month for the rest of their working life to get to there. There are not many people managing that. Don’t be put off though and remember that if you can’t afford to save as much as you’d like or need, save as much as you can. Your fortunes may well improve into the future and we have to hope that today’s austerity cannot last forever.
WHAT ABOUT THE TAX BENEFITS?
At present there is still 41 per cent income tax relief on pension savings although the Government has their eye on it.
Common sense would suggest they keep their hands off it. Income tax relief is absolutely essential in helping anyone save the nest egg needed for a decent retirement.
Approximately 650,000 people pay 41 per cent income tax once they earn €32,800 or more per annum according to Milliman, actuarial consultants.
If you are a higher rate taxpayer and save €100 into your pension – it goes straight into your savings, saving you 41 per cent income tax on this contribution. In other words, it costs you €59 to save €100.
To put it another way, with tax relief as it stands people can ask themselves: Will I save €100 into my pension or receive €59 into my hand after the taxman takes his cut? Will I save €200 into my pension or receive €118 after tax into my hand? And so on.
This relief makes up 41 per cent of your savings into your pension and is a must-have for ordinary private savers to reach their pension pot goals.
Without this relief it would be very difficult to save enough money.
DOES MY COMPANY HAVE A PENSION SCHEME?
It almost certainly does but it is alarming how many people do not join. It is even more alarming how many Irish companies – well known names that make a lot of money – give their employees little encouragement to do so.
A good employer will pay between 5 and 10 per cent of an employee’s annual salary into a company pension scheme.
If your company has a decent occupational pension scheme and you earn €40,000 per year, the company will be putting between €2,000 and €4,000 into your pension pot every year.
This is a serious benefit in austere times. Typically, you will have to match this contribution. Remember that tax relief of 41 per cent applies to those paying the higher rate while there is 20 per cent relief if you are a standard rate taxpayer.
SHOULD I BOTHER WITH AVCS?
Absolutely. Additional Voluntary Contributions are a turbo-charged way to get your pension moving.
Apart from anything else a pension top-up allows you to watch compound interest work in a very pleasing way.
You put in a hundred quid which is worth €110 in a year and then €121 a year later all the way up to retirement.
Very few people seem to understand how important and tax efficient a boost AVCs are to pension savings.
Industry sources say the take-up on AVCs is generally low.
The most important thing to know is they are simply another clever way to save money in addition to your main pension scheme contributions.
If you saved an extra €200 per month in AVCs, your extra fund would grow to €162,000 after 30 years. This money is in addition to your main scheme – we are assuming growth of 6 per cent per year and a 1 per cent annual management charge.
By any measure that is a lot of cash to have when you retire.
HOW MUCH EXTRA CAN YOU SAVE INTO YOUR PENSION AS A PERCENTAGE OF EARNINGS?
If you are under 30 you can put 12 per cent of your earnings into your pension and benefit from the tax relief.
Between 30 and 39, you can put in 20 per cent which rises to 25 per cent up to the age of 49 and up by another 5 per cent between the ages of 50 and 54 and by the same amount again when you are aged between 55 and 59. Anyone aged between 60 and 75 can put 40 per cent of earnings into their pension fund.
BUT PENSION PERFORMANCES ARE DREADFUL, CHARGES ARE TOO HIGH. WHY SHOULD I BOTHER?
The most recent 10-year annualised average managed pension fund performances have been poor compared with previous decades – we can thank the good people at Lehman Brothers and the ongoing financial crisis at home and abroad for that.
However bad and all as pension funds are doing, they have still beaten inflation with rates of return of almost 4 per cent per annum compared with an inflation rate of 1 per cent.
And the long term performances are still impressive at around 9.5 per cent annualised over 30 years to the end of last month. Had you saved €200 a year or €72,000 over the past 30 years in an average pension managed fund you would have a fund of around €300,000 today which is okay. And some investments are doing better than others.
There has been a lot of talk about Standard Life’s Global Absolute Return Strategies (GARS) fund in recent years. And it is not hard to see why.
It has delivered an annualised return of 8.1 per cent from September 2008 to September 2012 – during four particularly challenging years for the stock market.
IT IS ALL ABOUT MANAGED FUNDS, RIGHT?
It used to be but not any more. Pensions have moved on and managed pension funds are no longer the most common investment owned by ordinary investors.
There have been dramatic improvements in the choice and quality of pensions available to small savers even in the past six years. Pensions which were effectively only available to high net worth individuals (funds of €350,000 or more) can be availed of by ordinary savers from as little as €25 per month.
Many offer access to deposits, a wide range of funds, individual stocks, government bonds, even property in some cases depending on how much money you have and the provider’s terms and conditions.
WHAT KIND OF RISKS SHOULD I TAKE?
What age are you? The older you are the more cautious you should be.
If you are young, higher risk funds are appropriate – although the key is to put your eggs into different baskets and not do a Downton Abbey on it and put all your money into Canadian railway equities.
To save yourself a headache look towards funds which have a dynamic aspect where they de-risk you as time passes.
“Consider these because although your pension is a market investment few people look at their ‘performance’ regularly the way they might with privately held stocks,” Deeter says.
AND WHAT ABOUT THE FEES?
Management fees can be a wealth destroyer and by some estimates fees of more than 1 per cent can strip out almost a third of the value you would have gotten otherwise.
“Indexed funds and ETFs tend to have the lowest fees and over long periods of time few active managed funds are able to outperform the market regularly.
“Standard Life’s GARS is a rare example in that case but it hasn’t turned a decade old yet,” says Deeter.
Taxing issue for the minister on pensions: Why reliefs should be left alone in budget
IRELAND’S MIDDLE income earners have borne the brunt of government austerity measures introduced since the catastrophic collapse of Lehman Brothers just over four years ago.
Amongst the worst hit have been private pension savers who have seen themselves caught up in a near perfect storm, one which is wreaking havoc on private pension schemes in Ireland. Pension savers have lost over half a dozen valuable benefits and reliefs, suffered dreadful investment performance and been forced to steadily increase their contribution to the State coffers – by an additional ¤1 billion in 2011 – with a further ¤1 billion contribution expected for 2012.
Last year the sales of Irish life and pension products fell by 8 per cent while an estimated 80 per cent of defined benefit – or final salary – schemes are in deficit and cannot fully meet their obligations, something which will inevitably see some schemes wound up.
The pension levy of 0.6 per cent has cut the income of those in retirement reduced the capital sum already saved by members of private schemes and worse could be coming down the tracks if the Government reduces the tax relief on pension contributions from 41 per cent to 20 per cent – a move which would give savers fewer reasons to invest in a pension for their retirement “Why would anyone save into a pension if tax relief is offered at 20 per cent on the and way in and 41 per cent or more might be payable on the way out in retirement?” asks Nigel Dunne, chief executive, Standard Life Ireland.
“Income tax relief at 41 per cent is a must-have for private middle income savers if they are to have any hope of saving a decent-sized pension. Halving income tax relief would make it virtually impossible to save a sufficiently large fund to retire comfortably on,” he warns. It’s well documented, that private sector pension funding is already woefully inadequate and just half the working population has a pension.
This half is not saving nearly enough. The average private sector worker appears to be roughly four times worse off than their public sector peer in retirement with an average annuity income of EUR5,500 compared with the public sector average of EUR22,400. “Pension savers and the industry have done more than their fair share in the past three years – and should be left well alone in this year’s Budget,” Dunne insists. He says that savings incentives need to be kept in place “to avoid further exacerbating the nation’s pensions time bomb and putting huge pressure on the Government to increase state pensions in the future.”