October 31st deadline is crucial for pensions

Pensions are far more flexible products than they once were, with a number of packages available which can be tailored to individual needs. Dominic Coyle looks at what's on offer

Putting money away for your pension makes sense; everyone knows that. Unfortunately, report after report shows that only around half the working population is making some provision for retirement. The situation is particularly acute this year as self-employed people face an October 31st deadline for pensions contributions, unsure whether to trust money to funds that are heavily invested in a freefalling stock market. A report from pensions consultant Mercer last week showed that pension funds reported an average fall of 12.6 per cent in the three months to the end of September, bringing their 2002 loss to 20.6 per cent.

The Mercer figures indicate that Irish managed pension funds have shown a loss over the last three years and that the return over the past five years has failed to keep pace with inflation. However, the advice from the industry is not to worry.

"Over any reasonable cycle, savings in pension funds do well," says Ms Anne Maher, chief executive of the Pensions Board, which regulates pensions schemes and protects the interests of scheme members. Along with others in the industry, she stresses the long-term nature of pension investments, which accumulate over periods of 20 years and more. "While the situation with the markets is very worrying, there is no reason to suppose things will not come right," she says.

So should people start pension plans now or wait for the promised improvement? "If you miss the end-October deadline, you'll never get it back," says Mr Ian Veitch, head of market and product development at Hibernian.

"People need to remember that the Government is giving you more than they did to people taking out SSIAs." Pension contributions attract relief at people's marginal rate of income tax; for most, that means an effective handout of 42 cents for every euro put into pensions - a far more significant relief than others available to most of us.

The earlier people start putting money into a pension the better. The later you start the more money you will have to pay into a fund for the same out-turn as the money will have less time to produce the required return. Yet the latest figures from the Central Statistics Office show that only 46.8 per cent of PAYE workers have an occupational pension and the figure for the self-employed is even worse at 44 per cent. In both cases, women are less well provided for than their male counterparts.

Research from Hibernian shows that in the crucial 35-49 year age group, 49 per cent had made no retirement provision. According to Mr Veitch: "People in their forties should be putting 10-15 per cent of their annual salary into a pension plan if they expect to retire comfortably, let alone fulfil their retirement dreams."

Choosing the right package

For those who are interested, what are the options? Until recently, it was quite simple. If you were in an occupational scheme, it was almost certainly a defined benefit plan, where the employee received a certain benefit regardless of the performance of the underlying investments. How much you received was based on the number of years in employment.

More recently this has changed. Increasingly, both occupational and personal pension plan members are part of defined contribution plans. These deliver according to the underlying performance of the investments. Typically, 60-70 per cent of the funds in any plan will be in equities which, historically, have outperformed all other class of assets.

The thinking is that the younger the individual, the higher the proportion of their fund that will be in equities because, if things do go wrong - as now - there is plenty of time to recover. As people get older, their funds move increasingly out of shares and into lower risk Government bonds and, eventually, cash.

"That is one of the reasons the current squeeze on equities will not affect people close to retiring age," says Mr Veitch. "People who are retiring now or in the next few years will have had most of their funds in bonds and/or cash before the stock markets fell."

However, for those who manage their own funds and opted to stay in equities, the outlook is bleaker. They have a choice. Either put more money into their pension funds or get used to the idea of a lower pension.

Many people in occupational pension schemes will not build up enough years of service to give them the sort of pension they require in retirement. In simple terms, people are entitled to a pension of up to two-thirds of final salary. If your occupational pension plan allows the fairly conventional 1/60th of final earnings per annum of service, you would need to work 40 years to achieve the full pension. For these people, additional voluntary contributions (AVCs) have been a way of topping up your pension fund.

From next year, there will be another option - personal retirement savings accounts (PRSAs). These get around what has traditionally been one of the major drawbacks on pensions - portability. PRSAs are essentially a personal pension plan that you carry with you regardless of employment.

It has several advantages. PRSAs give people more direct control over their pension funds than in a traditional occupational pension. They can be switched between providers without charge and people can stop and start payments without penalty as their circumstances permit and they can contribute even if not in the formal workforce - for instance, women in the home.

On the downside, employers are not obliged to contribute to a PRSA in the same way they do with occupational schemes. Also, the plan-holder assumes all the risk. Charges on all PRSAs will be simple and transparent. On standard PRSAs charges will be capped at 5 per cent on contributions and 1 per cent of the accumulated assets per annum.

All employers not offering an occupational pension plan will be forced to offer a PRSA option to staff. The Pensions Board, which must approve PRSA products, hopes the first plans will be available by mid-February 2003. Sixteen providers have already indicated they will be looking to offer PRSAs to customers. Most significantly for the Pensions Board is the news that credit unions will be among them.

"Credit unions should reach a section of the population that has not traditionally been covered by the pensions industry," says Ms Maher.

In the context of PRSAs, it is worth remembering that charges should not be seen as the determining factor in choosing a pension plan, though it is worth keeping an eye on them. However, performance is still the dominant factor in determining the size of your final fund as the annual survey of pension funds indicates.

So who doesn't need a pension? Very few. The State pension may cover the requirements of some people at the bottom end of the earnings scale and, for those at the very top, ownership of companies, farms, property or other assets may provide sufficient income in retirement. For the rest of us, pensions are a must. If you doubt it, try living on the €147.30 a week before tax allowable under the contributory State pension.

Drawing down your pension

One of the major turn-offs about pension investment down the years has been the nature of compulsory annuities. For all the benefits of tax relief and the good sense of building up reserves during your working life to adequately fund your retirement, people have balked at putting their hard-earned cash into something that generally dies with them.

Annuities work by providing a set income for the person's retirement lifetime. The amount of that income is decided by:

the amount of money in your pension fund;

your age and health (for instance smokers, ironically, tend to receive higher annuities because they are actuarially more likely to die younger);

whether you want to have your payments indexed for inflation or whether you want to provide a pension for a spouse or other dependent;

interest rates when the annuity is taken out.

This last issue is one of the sore points for retiring annuitants in recent years. In an era of low interest rates the annuity rates have been tumbling - meaning that less money is paid to the pensioner. This has prompted many people to look at other ways of providing for their retirement - and giving up the generous tax relief available on pension savings.

In general, with annuities, as with most financial products, the more benefits you want, the lower the initial payout will be.

Providing a spousal pension is expensive, as is indexation or a guarantee that an annuity will be paid for a certain minimum number of years even if the pensioner dies early. Between them, such factors can reduce the initial pension payable by more than half.

The arrival of Approved Retirement Funds (ARFs) has been designed to counter concern that the insurance companies were making profits on the back of hard-earned savings. The central feature of ARFs is control. With these funds, people are no longer forced to take out an annuity at retirement and, if money remains in the fund at their death, it can be passed on as part of their estate.

Initially available only to the self-employed and to directors with a 20 per cent stake in a company, the legislation has since been widened to include people holding additional voluntary contributions (AVCs) and directors holdings only 5 per cent control of companies.

Basically, they allow people to decide upon retirement to move their pension fund into an ARF rather than an annuity. The money will continue to be invested in a manner over which you have a say and you can withdraw funds at any time, subject to investment restrictions and, of course, income tax. The fund can also be used at any time to purchase an annuity should annuity rates become more attractive.

Approved Minimum Retirement Funds (AMRF) operate in the same way as ARFs but are designed to counter fears that people would use their increased control over their retirement income to fritter it away and become a burden on the State. Although any investment gain on the capital can be withdrawn, the original capital sum must remain in the AMRF until the age of 75 at which stage, it can be withdrawn or used to buy an annuity.

People with ARFs need to keep an eye on the state of their fund and the performance of its investments. Withdrawals from ARFs will inevitably eat into the fund and, at some point, it will become more advantageous to switch to an annuity. When this will be depends on investment performance.

Annuities should not be dismissed. They serve a useful purpose in providing a guaranteed income for life free of the concern about the vagaries of investment performance. ARFs however allow the greater flexibility and control over their own destiny that people increasingly require. After all, with greater longevity, there is no reason why people at 65 should find themselves deprived of the right to control their lives and their finances - presuming they have had the good sense to build up a reasonable pension fund in the first place.