Pricewatch has been talking about pensions for almost as long as it takes to qualify for one but it is rare that we have ever started any class of pension-related conversation with good news. Most of the time we bang on about time bombs and deficits and we alarm people by telling them how they have most likely missed the boat heading towards future financial security.
But not this week.
That is because the Government announced details of a new auto-enrolment pension scheme which should, if all goes to plan, save many people from living out their golden years in penury and wishing they had listened to that Pricewatch fella back when they were young and sprightly.
We have been waiting a long time for such a scheme as the Minister for Social Protection Heather Humphreys admitted last week when unveiling the details of a plan which will see around 750,000 private sector workers, over the age of 23 and under the age of 60 who earn more than €20,000 per year automatically enrolled in a pension scheme if they are not already signed up to an occupational pension scheme.
Workers and their employers will both contribute 1.5 per cent of the employees salary to the pension pot while the Government will add an additional €1 for every €3 invested by the worker. The money will be invested until the employee reaches retirement age.
Contributions will climb gradually and annually over the first 10 years of the scheme from matching 1.5 per cent of gross salary payments in the first three years, to 3 per cent in year four, 4.5 per cent from year seven and hitting 6 per cent in year 10.
People who are automatically signed up to the scheme will be able to walk away from it during a two-month window after six months, although they will only get back their own contributions and not their employer’s or the Government’s share and then, after two years, they will automatically be re-enrolled.
“This represents a significant milestone in implementing one of our key Programme for Government commitments. Every worker will have access to a workplace pension,” Humphreys said, adding that it would change a system that has previously left workers “to their own devices to navigate what is a complex world of pensions, to one in which choices and options are simplified on their behalf”.
A central processing authority will be established to oversee the scheme and the money in the pension funds will be invested by four registered providers in four different investment portfolios of varying levels of risk. Management fees will be capped at a “maximum envisaged” level of 0.5 per cent of assets under management.
The pension savings will transfer with a worker if they switch jobs, so employees will not have to move their pension across to a new scheme.
While anything that gets more people to start investing in a pension earlier with the added bonus of a Government contribution might seem like a great idea, there was some disquiet expressed by some in the industry last week.
Moyagh Murdock, the chief executive of Insurance Ireland, seemed downbeat in her hot take. “The Irish pensions landscape is already extremely complicated with multiple and often overlapping products and rules and there is a risk that auto enrolment will add to this,” she said as she called for the current pension structure to be simplified.
Brokers Ireland didn’t get the bunting out either. While its director of financial services, Rachel McGovern, said she agreed “in principle with the introduction of an auto-enrolment pension scheme”, she warned that the timing was “likely to be difficult for individuals affected by the current increased cost of living. Employers are also likely to be concerned about the timing of the introduction of auto enrolment with some still ‘on their knees’ from the events of the last two years.”
She also expressed disappointment with “key aspects of the proposals” and said that “with a limit of 0.5 per cent on administrative, management and investment charges, it will not facilitate independent advice for consumers”, and she questioned the need for a centralised processing authority. “This will have to be funded from somewhere. Is that somewhere contributor savings or is it going to be funded elsewhere? There is also a risk that it could become another Irish Water’,” she warned.
'Long overdue for the one-third of employees that currently have no supplementary income outside of the State pension'
Ray McKenna of employee benefits advisers Lockton was more optimistic. He described it as “a very welcome announcement that is long overdue for the one-third of employees that currently have no supplementary income outside of the State pension”.
He did, however, warn that there’s still a lot of work to be done to ensure scheme goes live in 2024. “Critically, the Government will need to press the go-live button when it’s ready, and we would be concerned that, just like other pension decisions such as increasing the retirement age, there may be a reluctance to act.”
And we can’t really afford a reluctance to act any more.
Pensions – the basics
Let’s start with the most basic question. What is the retirement age in Ireland?
You’d think that was basic wouldn’t you, but it’s not. Many employees retire from their jobs at 65 but the State pension doesn’t kick in until people turn 66 and there are plans to push that out, although we don’t know when that might happen. It was due to happen last year but became something of a political hot potato and was quickly dropped. We should know more about the plans for retirement in the future later this month.
But I thought retirement at 65 was set in stone for good reasons?
The reasons are more arbitrary than good, to be honest. The age of 65 was first set by German chancellor Otto Von Bismarck in the 1860s.
And why did he pick 65?
Well, he wanted to ease social unrest by showing himself to be socially progressive – not a common feature of European leaders in the 19th century. But the canny German didn’t want to pay too much for pensions, and with the average German living fewer than 65 years he was pretty sure most of his citizens would never get their hands on his socially progressive pension. But life expectancy – at least in the wealthy West, has increased dramatically over the past 150 years. Today Irish women can reasonably expect to live beyond 84 while – all things being equal – men will live until they hit 80. That is a lot of years of retirement income.
That’s good news, right?
It is great news but it does pose a problem. Right now there are around five workers paying tax and PRSI for every retiree, but by the time we get to 2050 that figure is expected to be two workers per retiree. That is going to place a large burden on those two workers and on the State’s coffers in the years ahead.
So that is where my private pension comes in, right?
Right. That is why the auto-enrolment scheme is so important. If the State pension won’t keep us going we will need our own money too, but half of us don’t have any class of private pension.
How much will I need in my pension fund when the time comes?
The average size of a private pension in Ireland is about €5,400 a year. Add that to the maximum State pension of €12,900 and you will have a retirement income of €18,400 per year or €1,533 per month. You are probably best placed to decide if that will be enough to allow you to live in the manner to which you have become accustomed. The basic rule of thumb is that an “adequate” gross retirement income is about 50 per cent of gross pre-retirement income. So if you earn €80,000 on the day you retire, you need a pension income of €40,000. If you are one of the lucky ones who gets the maximum State pension of €12,900 then you will need about €27,000. To get to that magic number, you would need a fund of between €700,000 and €950,000.
And how much will I need to save to get that?
That really depends on how old you are and how much you can save. if you want a private pension pot of around €20,000 per year and you start saving at 25, you will need to put aside around €300 gross per month. With tax relief at the top rate, it actually costs you only €164. If you start at 35, then you need to save around €500 a month before tax, while if you start at 45 then the monthly gross savings come in at close to a grand. Adding the 20 grand to the state pension will give you a pension of close to €33,000.
You mentioned tax relief is that still on the table?
It absolutely is. Saving for a pension actually gives you a triple bounce when it comes to tax. You can get a tax break on contributions, on investment growth and 25 per cent tax-free at retirement. On contributions, you can receive up to 40 per cent income tax relief (after USC and PRSI are paid) if you are a higher-rate taxpayer. Deposits in banks, credit unions and the rest charge Dirt at 33 per cent while investment growth of the fund over 30-40 years or more is tax-free and compound interest also performs its magic. And for defined-contribution pension savers based on your own savings, employer contributions (if they contribute) and stock-market returns, at retirement age you are entitled to take 25 per cent of your fund tax-free.
And what are the returns on a pension?
That depends on where you invest your money and when you cash it in, but over the past 30 years the average actively managed pension fund has returned around 8 per cent per year. If you had saved €250 per month over this 36-year period, your total savings would have been €107,750 and your total pot would have been €627,665 after charges, or almost six times your money back.
What about pension charges?
Charges occur at various stages: when a pension plan is set up, during the contribution phase and when a member exits from a plan. The charges can be borne by either the employer or the member. Anyone making a pension move or decision should consider the effect of charges. If they are too high, they can really eat into your pension pot.
What about topping up my pension?
Additional voluntary contributions (AVCs) are useful for those behind in their retirement savings or uncertain about the future value of their final-salary pension scheme, and will grow your pension pot quickly. Even if you can only afford 50 quid a month, it will add up over time.
A financial adviser’s view
Laura Doyle is the managing director of Progressive Financial Services in Dublin and has been preaching about pensions for years now. She is as good a poster-child for investing in your future as it is possible to get, and it is hard to argue with her when she crunches the numbers.
When asked what difference it makes to the size of a pension pot if someone starts putting money aside in the mid-20s compare to their mid 40s, she breaks it down in stark terms.
”Based on a salary of €40,000, it would only cost €100 per month to save €2,000 per annum when you factor in the tax relief. If a person pays in from age 25, they’ll have around €60,000 in the pot come their mid-40s; if they continue paying at the same rate, by age 70 there’d be €250,000 in the pot.
“Whereas the person who started paying the same amount from age 45 would only have around €87,000 by age 70. So those extra 20 years of paying in €100 per month only cost the person €24,000 – €100 x 12 months x 20 years – but increased their pot size by €163,000.”
'Pensions are over-complicated and people – young and old – through no fault of their own, don't understand the value of them'
When asked what she thinks are the main obstacles to people – particularly young people – starting a pension, she points to two main barriers. “People’s perception of pensions, and bad marketing. Pensions are over-complicated and people – young and old – through no fault of their own, don’t understand the value of them.
“Over the past five years I’ve seen an increase in demand for investing – there’s a big appetite for trading platforms like eToro and Degiro, so why not the same for pensions? You can invest your pension in all the same shares or ETFs, but with one massive advantage – tax relief. It’s essentially free money, and by not paying into a pension you’re missing out on it.”
She does have sympathy for someone in their 20s who just can’t get their head around the need to plan for life in their 70s. “Planning for the short to medium term can seem impossible at that age, let alone 40+ years down the tracks. However, I would position paying into a pension at that age for the sole benefit of tax relief. And the power of compound interest cannot be understated: even paying a nominal amount, €10 per week, would make a massive difference when it comes to proper retirement planning in late 30s or early 40s.”
If her number crunching doesn’t convince people, what else would she say to someone to try to persuade them to start a pension?
“Honestly, I just have conversations with people and show them the value of paying into a pension, and what they’re missing out on by not paying into one. Almost everyone will proceed at some level – affordability is always an important factor, but with the minimum contribution starting at €10 per week and the flexibility of being able to increase/decrease or stop/start your contributions, there’s an option for everyone no matter what their circumstances.”
She is not entirely convinced the auto-enrolment scheme will be the game-changer some are hoping it will be. “I don’t necessarily think it will appeal to them, they might just see it as another deduction and less take-home pay if it isn’t rolled out properly,” she says. “I think we underestimate the younger generation and have to give them more credit on their ability to make decisions for their future.”