What you need to know about pensions

Now that the dust has settled on the election – sort of – it’s as good a time as any to look at one of the topics that threatened to become hot during the course of the campaign.

Pensions–- and yes, that might well be the first time pensions have ever been described as hot.

Just how hot pensions were is open to debate, mind you. According to the exit poll published by The Irish Times, it was the third most important issue people voted on. But just 8 per cent said pensions mattered most to them when voting and it was a long way behind housing and healthcare. Proposed changes to the pension age did not rate as an issue at all for the youngest voters.

So if it mattered to only 8 per cent of voters and the election has now passed, can we forget about the topic until the next election?

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Sadly no. While pensions and election cycles are not easy bedfellows, with the former playing out over several decades and the latter focusing on what happens over a five-year period, the conversation must continue. Because no matter what your political persuasion is, we are living in troubling times because we are all living longer. While that is obviously good news, it is not problem-free.

When German chancellor Otto Von Bismarck introduced a state pension in the 1860s, he set the age at 65, knowing full well that few of his countrymen would live to collect it. However, life expectancy in this part of the world has increased dramatically over the last 150 years and women can reasonably expect to live beyond 84 while – all things being equal – men will live until they hit 80.

People in Ireland who turn 65 in 2020 will, on average, live 50 per cent longer than people who reached that age in 1970 and while there are now about five workers paying tax and PRSI for every retiree, in 30 years’ time that figure will be two workers per retiree.

That is going to place a large burden on the State’s coffers in the years ahead and private pensions do not look like they are remotely ready to fill the gap.

A study published earlier this month found that almost half of Ireland’s workers have no private pension, with 37 per cent of this cohort saying high rent and other day-to-day bills were making it impossible for them to afford it and almost one in five saying they did not know how to start a pension.

According to the Matrix Recruitment pension survey, of the 52 per cent who said they contributed to a pension, 41 per cent said they were not confident it would be enough to live off in retirement, while 31 per cent responded that they simply didn’t know if their pension would be enough for retirement.

And how much is enough? Probably more than you think. “Irish people’s standard of living has rocketed in the past 30 years and most people want to maintain their standard of living in retirement, so it is important to save enough to live comfortably,” says Sinéad McEvoy, pensions technical manager with Standard Life.

“People owning pensions and, secondly, saving enough into them are two major issues in Ireland,” she says.

If about half of the private sector has a pension and the average size is about €5,400 is that enough? No, McEvoy says. “This is not enough to live on even if you qualify for the maximum State pension of €12,900. A combined retirement income of €18,400 per annum will not stretch to paying the bills, running a car, holidays abroad,” she says.

The cost of paying into a pension is a big concern for many people. “The more traditional reasons for people not starting a pension have been well documented,” says Breda Dooley of Matrix Recruitment. “Lack of knowledge, inertia and the assumption that a pension is not relevant are all issues people generally reference.

“But now, according to these findings, we are seeing a significant number of people without a pension saying that they can’t afford it. What makes this more worrying is that with Ireland’s growing ageing population and the pension savings gap getting wider, the real question is: can people afford not to have a pension?”

So when it comes to pensions what more do you need to know. Pricewatch asked some questions and then tried to answer them.

Do I need a private pension? Will the State not look after me?

Don’t count on it. The maximum State pension right now is €12,900 – that is just under €250 a week, so if you fancy spending your golden years taking round-the-world trips, trekking to Machu Picchu and doing other fun things you had put off earlier in life because of work and family commitments, then you will need more than that.

How much more will I need?

That depends. Most experts suggest 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 get 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.

Is that a lot? It sounds like a lot.

It is. Pricewatch asked asked the number-crunchers at Standard Life to work out how much we would need to put aside. To retire with a private pension of €19,500 a year – which is half the average industrial wage – at at age 68, you need to save a fund of €463,900.

The cost of saving to get to the same final amount almost doubles every 10 years you delay saving. So if you start saving at 25 you will need to put aside a gross sum of €301 per month. With tax relief at the top rate, it is actually €164. If you start at 35, then you need to put aside €519 a month before tax, which works out at €283 with the reliefs in place. And if you start at 45 then the monthly gross savings come in at €969, which is €529 with tax relief.

The above excludes the maximum State pension of €12,900. If you combine it with the €19,500, you get an annual income of €32,400, which is close to the average person’s desired retirement income of about €35,000.

There’s a big difference between starting at 25 and 45?

Yep: every 10 years that you delay starting saving means you double the cost of how much you need to put away to get to the same place when you retire.

When will I get the State pension?

Well isn’t that the €13,000 question. As it stands the qualifying age for the old-age pension is 66 but it will rise to 67 in 2021 and then 68 in 2028, with a jobseeker’s payment for those who retire now at 65 to take them to age 66 when the pension kicks in. But the jobseeker’s allowance lasts only nine months: after that, applicants are subject to a means test. In 2021, the situation gets worse with the gap moving from one year to two and people relying on means-tested allowances for even longer. Of course, all this depends on what a new government will do, with some parties suggesting they want to see the age return to 65. However, if a person aged 65 or over has at least 156 PRSI contribution weeks paid they will continue to receive Jobseekers Benefit even when benefit exhausts, until they reach State pension age.

Will that fix the pension crisis?

No. It can only really be solved by working longer, paying more PRSI or accepting a lower or even a means-tested State pension. It is worth noting that a pension age of 65 came in only in the 1970s – before that, the pension age in Ireland was 70.

Should I join my company scheme?

Absolutely. A good employer will pay between 5 and 10 per cent of your annual salary into a pension scheme. If your company has a decent scheme and you earn €40,000 per year, the company will put between €2,000 and €4,000 into your pension pot every year. You will have to match at least some of this contribution.

What are the tax implications?

Saving into your pension is arguably the best and most needed tax break left. It takes a good chunk of time, adequate saving and good investment choices to produce a decent-sized pot. Revenue knows this, hence the tax breaks provided.

Most people still don’t realise saving into a pension is tax-efficient, which is a shame. A Standard Life survey last year found that 59 per cent of people either do not know pensions are tax-efficient or think they’re not.

Tell me more.

Well, pensions have a triple tax efficiency – contributions, 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 earning €35,501 or more. Why would you pay 40 per cent of your income to the taxman if you could afford for it to go directly to your pension pot and pay for a decent retirement? Standard-rate taxpayers receive tax relief at 20 per cent – which is still a valuable tax relief for savers.

This contrasts with deposits in banks, credit unions, etc, where Dirt is charged at 33 per cent. Investment growth of the fund over 30-40 years or more is tax-free and compound interest also performs its magic.

For defined-contribution pension savers based on your own savings, employers’ contributions – if they contribute – and stock-market returns, at retirement age you are entitled to take 25 per cent of your fund tax-free.

Back up for a second: where does the State pension actually come from?

It is paid from the social insurance fund – PRSI payments go into this fund and welfare payments, including the State pension, come out of it.

How is that fund doing right now?

Not badly, as it happens. The fund recently returned to surplus as a surge in employment saw more PRSI payments going into the pot. But all the signs are pointing to trouble in the future as an increasing number of older people as a proportion of the population will mean the fund will struggle.

What can be done?

Well, the State pension can be tackled and people can be encouraged to start saving towards their retirement income needs using something called “auto-enrolment”.

What is that?

It would see every worker automatically enrolled in a pension scheme – obviously enough. The move would affect about 600,000 private-sector workers who are not part of a private work-based, or occupational, pension scheme.

The idea is that all workers between the ages of 23 and 60 who earn more than €20,000 per year would be enrolled in the scheme unless they were already members of an occupational scheme. As a starting point they would pay 1.5 per cent of their gross income into the scheme, rising over time to 6 per cent. That would be matched by the employer. The State would also make a contribution – this was suggested at €1 for every €3 contributed into the scheme.

In an auto-enrolment scheme a worker could choose proactively to opt out at a point within two months after making six months of contributions . The thinking is that most people, once they were in, would simply stay in. But, if not, the proposal is that they would be re-enrolled at a later point when, possibly, they would be more mature and more open to the concept of pension saving.

Workers would have a choice of investment funds, albeit a fairly select one: if they didn’t make a choice, their money would go to a default fund. The pension they got on retirement would be determined by how much they contributed and how good the investment fund performance was.

That sounds sensible – is it going to happen?

The finer details are still being ironed out and, as with all things in Ireland, just because something is sensible does not mean it will happen, particularly if it is politicised. And make no mistake, pensions are a political hot potato.

So I need a private pension: where should I start?

According to Standard Life’s McEvoy there are “lots of different type of pension pots with varying returns. That said, the oldest and one of the best-owned pension funds in the marketplace over the last 30 years is the pension managed fund”.

At the risk of sounding like the tracker mortgage guy on the bus, I don’t know what a managed fund is.

Typically it contains a spread of equities – somewhere between 50 and 70 per cent, usually – with the remainder in lower-risk assets such as bonds, cash and property.

What are the returns?

They are not bad really, all things considered. Over the last 30 years the average active-managed pension fund has returned a very healthy 8.24 per cent per annum. McEvoy says her own company’s active-managed pension fund “returned a chunky 8.9 per cent per annum over almost 36 years”.

What does that mean in cash terms?

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.

Generally speaking, how are pension funds doing?

There are good years and there are bad years. Last year was a good one – the average Irish active-managed pension fund produced bumper returns in 2019, making it the best year for investment returns in a decade. Its value increased by more than a fifth or a return of 20.6 per cent over 12 months, according to Rubicon Investment Consulting,

And what about 2018?

You had to ask, didn’t you? That was the worst for Irish pension fund investors in the previous 10 years, as all funds lost ground, with the average loss coming to 5.2 per cent. Rubicon has figures for the past 20 years, which show that the average annual return over the period was 4.7 per cent. That covers a period that includes the heady years of the Celtic Tiger and the subsequent markets crash and recession.

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.

What about topping up my pension?

Additional voluntary contributions (AVCs) are most useful for those behind in their retirement saving or uncertain about the future value of their final-salary pension scheme. If you are starting out and have no serious drains on your finances other than nightclubs and fancy shoes, put a few bob into AVCs. They will grow your pension pot quickly and give you greater control and independence from pension shocks.