Why take risk with cash when State savings give the same return?
Q&A: Dominic Coyle
Do high-risk investments produce a greater return than State-backed low-interest savings products? Photograph: Bloomberg News/Hannelore Foerster
I have retired recently and have €200,000 to invest. On talking with an Irish life advisor today I understand the following to be true of them and probably everyone else in the private market.
Irish Life scenario; I put my money into one of their very high risk funds, all €200,000 of it. I leave it there for seven years. Irish Life take 1.4 per cent per year management fees. I am extremely lucky and at the end of seven years my fund is worth €300,000. Thus the average fund is €250,000 and Irish Life take approx 10 per cent over the seven years. That’s approx €25,000 to Irish Life.
After seven years Irish Life is forced by Revenue regulations to pay “Exit Tax” on the profits in my fund. Thus with a profit of €100,000 I pay the Revenue €41,000 and Irish Life give me my original €200,000 plus €49,000 approx.
State Savings scenario; I place the €200,000 with State Savings for 10 years. If we ignore the seven years vs 10-year difference, after 10 years the State Savings hands me back my original €200,000 plus 25 per cent (guaranteed overall return after DIRT) which is €50,000 to give a total of €250,000.
Essentially I get the same return with either party. However, I have had to endure seven years of extremely high risk investments which could in fact crash and lose my money. Alternatively I go with State Savings, with no risk whatever, and get a return equivalent to the private investment option.
Am I missing something here?
Mr J.W., email
I suppose, at the outset, it should be noted that the position is not going to be unique to Irish Life. Clearly, they’re the people you’ve spoken to and they are the largest player in the Irish market but the broad figures are likely to be replicated through the industry.
That being said, your experience raises some interesting points, though you are missing a few things. You don’t say which investment Irish Life was discussing with you but, for lump sum investments, one of its main platforms at the moment is the Clear Invest product. It offers a range of plans defined by their risk level – Multi-Asset Portfolio Fund 2 - 6. The lower the number, the lower the risk.
By way of illustration, it offers a guide to how an investment in Multi-Asset Portfolio Fund 4 – which it describes as a medium risk fund – could perform. It gives two scenarios – one where the fund grows at a rate of 4.5 per cent per annum and one where it does better, growing at 6.25 per cent annually.
Taking the better performance, it says that over seven years expenses and charges will account for over 13 per cent of your original investment, a figure that rises to more than 20 per cent of the investment in year 10.
Irish Life itself says that the impact of fees and charges would reduce the 6.25 per cent assumed headline growth rate by 1.8 percentage points – i.e. the underlying real growth to you is closer to 4.45 per cent.
That’s not all. As you mention, once an investment in the fund has passed its seventh anniversary, the fund manager is obliged to pay tax on the fund to the Revenue. This is to stop perceived abuse of the gross roll-up system where funds remain invested for their lifetime and “exit tax” is paid when you cash in the investment.The tax is levied at 41 per cent of the gain in the investment.
After seven years, the tax paid on your fund will amount to almost 14.5 per cent of your original investment, rising to 21.5 per cent of the investment in year 10.
So, what’s left? Well, according to the Irish Life illustration, after seven years, your investment will have grown by just under 21 per cent net of taxes and charges. If you leave it invested for the 10 years, your gain will be around 31 per cent – i.e. your €200,000 investment will be worth €261,800.
And yes, that’s assuming nothing goes wrong and the investments lose value. With a higher risk fund, you would expect the potential reward to be greater but so too the risk of losing some or all of your original investment.
Well, the NTMA has recently reduced sharply the interest on offer on State savings. This is because it can borrow money very cheaply elsewhere. In fact, last week, it attracted people to buy €500 million of short-term debt who were actually willing to pay the NTMA for the privilege of lending the State money. Bizarre.
As a result, it is not as much in need of money from ordinary punters through the solidarity bond, savings bonds or saving certificates.
That means that, from earlier this month, it is offering only 1.5 per cent per annum on these bonds – or 16 per cent over the 10-year term, not the 25 per cent you might have got previously. So, your €200,000 investment would return only €232,000 at the end of the term.
Of course, this is risk-free, and backed by the State. It is still short of what Irish Life reckons it might deliver if, and that’s a very big “small” word, investment performance hits its projections.
That brings me back to something raised last week. I noted that state savings are exempt not only from DIRT but also from income tax, universal social charge and PRSI.
Several readers wrote in to question this assertion.
It is true that earlier issues of the National Solidarity 10-year bond – issues 1-3 specifically – did feature DIRT tax on annual interest though not on bonus payments. Such annual interest was also subject to PRSI for those people who paid PRSI. However, since issue 4 of the National Solidarity Bond which was first marketed in December 2013, no tax applies on this product, including DIRT, USC, PRSI and income tax. Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or email firstname.lastname@example.org. This column is a reader service and is not intended to replace professional advice