REDUCING their income tax bill is a priority at this time of year with many self-employed people and company directors who must file their annual tax returns by January 31st. The most popular and beneficial way to do this is to take out a personal pension plan.
Pension take-up amongst the self-employed is very low the figure is even lower for farmers, one of the biggest self-employed groups in the country.
The other difficulty is that most people leave their pension investment very late. Combine this with the funding restriction imposed by the Revenue Commissioners (a maximum of 15 per cent of net relevant earnings, 20 per cent if you are over age 55) and many people discover that the value of their pension is going to fall far short of their final year's annual earnings.
In his Money PAYE and Tax Guide, Sebastian Devlin of the Taxation Advice Bureau illustrates the contributions difficulty with the following table which shows the sort of retirement income as percentage of your final salary you can expect if you fund your pension to the tune of 10 per cent of net relevant earnings.
The 35 year-old self-employed person who thinks he is being very responsible by taking out a pension early and puts, say, £2,000 a year into a fund (i.e. 10 per cent of his net earnings) should probably think of other ways to enhance his retirement since his pension is only likely to produce 43 per cent of his final income. Had he started saving 10 years earlier he could have expected a pension worth nearly 60 per cent of his final earnings. (Had he put 15 per cent of his earnings away from age 35 he would have come considerably closer to full funding.)
The strongest argument in favour of early pension contributions is the substantial tax relief: for every £100 saved, the real cost is just £52 for someone on the highest rate of income tax. For a self-employed person with relatively high, net relevant earnings of say, £30,000, contributions of £4,500 (the maximum 15 per cent funding limit) will only cost him £2,340. Income tax, it should be noted will have to be paid on the pension income upon retirement.
Choosing which pension is most suitable is the really difficult part of the whole procedure, with a number of important factors to keep in mind. Top of the checklist should be your current age, the age at which you wish to retire and your level of financial expectations versus your risk tolerance level.
Once all the detail is established you can start searching out a pension that matches those factors. Ideally, you should use the services of a good financial adviser, preferably one with adequate stature to demand a better charges/cash allocation (i.e. a lower bid/offer spread) with the insurer and who will ideally charge you a reasonable fee in lieu of the standard commission agreement. Such a fee should not, over the course of your contract have a higher impact on the value of the fund than the commission structure.
Commission driven brokers are loath to admit that the charging structure of a pension product has any long-term impact on good performing pension fund, but the simple fact is that not everyone stays the course of a 20, 25 or 30-year lead-up to retirement. Some of us become employees again others become unemployed through disability others die young. A high, front-loaded charges structure can have a devastating effect on early pension values (one of the reasons why a number of pension manufactures have opted to spread charges.) Equitable Life, for example, has been able to achieve among the highest consistent returns because of its no-commission, low charges structure.
What the pension brokers prefer to emphasise - and so they should - is fund performance. Every extra 1 per cent growth can translate into thousands of extra pounds built up in a long-term pension fund and so it is vitally important that you compare the performance (and charges) track record of the pension fund managers. A low cost charging structure on its own is no good without consistently good growth figures; similarly, excellent fund performance with high charges will only result in disappointment when upon retirement you discover that a large chunk of your fund was eaten away by charges and commissions.
Virtually all the major life and pensions companies are launching new or revised pension plans this month: the bank assurer Ark Life has restructured its costs and charges to heighten its competitiveness and has included features like a tracker bond pension option. Unfortunately its fund performance record has been below average for many years. Norwich Union, one of the consistently strong performers, and one of the few with-profit pension providers left in the market, has introduced a new range of unit-linked pension funds in the run-up to its demutualisation.
These new Norwich contracts offer all the standard options - such as the ability to switch in and out of different asset funds, to stop and start contributions, to add life assurance, PHI and disability and to buy your final pension annuity on the open market. Bonus units are also on offer at the beginning and end of the new unit-link contracts. Norwich has also added an attractive benefit (approved by the Revenue) which allows that your pension can be paid early in the event of total and permanent disability.
Despite falling bonus levels, many brokers are still advising clients of the merits of with-profit pensions, which it must be said, are not as transparent as unit-linked ones.
"Even with bonuses coming down, with profit funds are still outperforming unit-linked ones. I don't think you can beat them; they have never let me down," says Ross Barry, a Dublin-based broker and regular contributor to Family Money.
His views are shared by Sinead Burke from Sedgwick Dineen IPT whose only complaint is that there are fewer and fewer true with-profit pensions, complete with bonus guarantees out there. Friends Provident and Standard Life are now offering the unitised version. Only Scottish Provident, Norwich and Equitable offer the traditional with-profit contract which I think is a good choice for an older contributor. A younger person should probably have a greater allocation in equities, but might also want at least one with profit fund in their pension portfolio."
The advice of most of the professionals is that despite the time pressures, the tax benefit of a pension investment should not compel you to buy the first product that comes along. Some contracts, are cheaper, they all perform at different levels. Shop carefully for a pension and spread your risk by buying two or three different company funds.
Anyone who is unsure about the level of their earnings from year-to-year, they say, should opt for a single premium (i.e. lump sum) pension in which there is a very small upfront charge (usually 3 per cent of the contribution) plus the usual bid-offer spread and annual management fee. A regular savings plan will probably suit someone with a regular income though the charges and the amount of money allocated to your fund in the early years can appear disproportionately lower. The pension companies assure us that the different charges balance out over the long term to retirement.
