Pensions or other investment vehicles?
With a pension you get a raft of tax benefits and your employer contributes too – giving you a bigger bang for your buck
Pay into a non-pension investment scheme and you will pay tax, pay exit tax and dirt tax
Anyone considering the relative merits and demerits of pensions vis-à-vis other investment vehicles will find it a surprisingly short exercise. Quite simply, there’s no comparison.
“Where you have the capacity to invest in a pension, my view is that it should be pretty much the only game in town. Why would you forgo the tax advantages of investing through a pension when compared to investing personally? Tax relief on contributions, tax free investment growth and a tax free lump sum – it should be a no-brainer,” says Colm Power, financial planning manager at Davy.
You can access almost all of the same investments through a self-directed pension that you can personally – managed funds, company shares, unlisted investments, private equity, direct property.
“There are some additional restrictions that apply to pension investments – for example, you can’t buy a house through your pension and have your kids live there when they are in college – but you can buy a house nonetheless,” he says. “And rent and gains are tax free within the pension. So, generally speaking, you can get the same exposure to investments through a self-directed pension as you can personally but with additional tax advantages.”
The difficulty – and one that he sees particularly with company group defined contribution schemes – is that investment options are often limited to a small number of managed funds. “For a lot of people these are uninteresting or are hard to understand. This isn’t necessarily a bad thing, your retirement savings shouldn’t be too exciting, too much choice can be a bad thing and these schemes are generally very low cost. But it can also cause people to disengage completely with their investments. And this is obviously a big challenge for both the industry and policy makers,” says Power who, in most circumstances, would only start to look at alternative areas for investment where capacity to invest through a pension has been used up or where funds were needed for other purposes.
“So the key thing is to look at your objective for the investment. Why am I investing in the first place? It’s also important to consider whether I can afford to lose any of the money I am investing,” he advises.
For investors with longer term objectives looking outside of their pension, it is possible to access balanced, diversified investment portfolios through a fund of funds that can give you gross roll-up investment returns for up to an eight-year period, he points out. “So this can provide the same type of returns as managed funds found in most group DC pensions. You would ultimately pay fund exit tax at 41 per cent on crystallising any gains.”
Another popular investment type for higher net worth investors are private equity funds. However, these carry a higher level of risk, are long term and only suitable for sophisticated investors. “Private equity strategies focus on longer-term results and aim to generate positive returns for their investors in any market environment. Against the current backdrop of robustly-valued equity markets, and low-yielding bonds and deposits, we believe that the current outlook for private equity is attractive relative to traditional investments,” says Power.
Pensions, savings and investment accounts are essentially all variations on the same theme, it’s just that they have different rules, regulations – and tax reliefs.
“A pension is a vehicle used for the long term, typically you won’t get access to it until age 60. A savings product is shorter term and not locked in. But the advantage of pension savings is that the tax man helps out. You get tax relief on contributions, the fund grows tax free and you can take a tax free lump sum,” says Brian Kingston, investment manager at Investec.
With savings, by contrast, you are talking about a deposit account, which is hit by Dirt tax (currently 39 per cent) or a life company based investment product, which is hit with an exit tax, currently 41 per cent.
“For many people starting to look at retirement savings, the fear is that they are locking money up by putting it in to a pension. So we say to them, if you think you can contribute €1,000 a month, for example, put €500 into your pension and put €500 into a savings account. If you still have your savings after a year, you’ll know you can live without it and you can put some or all of that into your pension too,” he says.
A pension scheme is only the “tax wrapper”, points out Munro O’Dwyer, pension partner at PWC. “Yes you can save for yourself, but you will do much better if you can get your employer to pay into it too.” Pay into a non-pension investment scheme and you will pay tax, pay exit tax and dirt tax. With a pension you not only get the raft of tax benefits above – including making tax-free contributions, but your employer contributes too, giving you way more bang for your buck. “It really is a superb way to do it. It’s like SSIAs, only better,” he says.