Tax breaks play key role in hitting €400,000 pension target

Harry Crummy is a pension consultant with Efficient Financial. He views pensions as key to enjoying retirement. "Having worked hard during your lifetime you will want to pursue your hobbies and normal activities during your retirement years. This will require a reasonable level of income and therefore will require a reasonable amount of savings or investments to produce this income. The State pension of €248 per week will not be enough on its own."

The good news is that pensions are the most tax efficient investment enabling people to prepare for retirement.

“The favourable tax treatment of retirement contributions and retirement funds are designed to assist individuals to accumulate long-term savings. The benefit of these cannot be overstated, tax back on the contributions, and tax-free growth over a long period of time are key elements to establishing a reasonable income in your retirement years,” he says.

When you contribute to a company pension scheme, the net cost or the “real” cost to you is not as high as you would initially think. The Government provides generous tax relief at your highest tax rate to encourage pensions saving.

In other words, if your income levels bring you into the higher income tax bracket then you get tax relief at that rate. Likewise, if your income level means that you are paying tax at the lower rate only, then this is the rate at which you get the tax relief.

There are a myriad of reasons why married couples may think that €36,000 of retirement income will not fulfil their plans

For example, for every €100 you contribute, your take-home pay will only be reduced by €60 if you pay tax at 40 per cent (as of January 2015) and by €80 if you pay tax at 20 per cent. The €100 is invested into your pension plan.

While some employees may struggle in their 30s and 40s to make material pension contributions (due to financial commitments such as mortgages and childcare, etc) the current Revenue system permits many employees to make generous contributions in their 50s and early 60s when they may have fewer financial commitments, allowing them to “play catch-up” in their bid to build a retirement fund target.

Expected retirement

Andrew Cree, financial planner with Imperious Wealth, agrees but the figure desired is higher than might be expected.

“A question I am often asked about financial advice for couples is what sum we should target in our pension funds at our expected retirement at 65 years of age. When I reply that an optimal joint pension fund is €400,000, I am often met with an incredulous stare.

"I would argue that it's not just a question of how much pre-tax income one needs to replace in retirement, the focus should be on building a tax effective pension plan which involves planning to reduce your taxable income to a minimum in retirement. Under Revenue rules, a married couple in Ireland (over age 65) have an annual income tax exemption of €36,000 jointly and will pay zero per cent tax rate, while for income earned over €36,000, they will pay the marginal rate of tax."

So, there are a myriad of reasons why married couples may think that €36,000 of retirement income will not fulfil their plans, the good news is that if they sit down with their financial adviser to build their retirement target fund greater than €400,000, they will be pleasantly surprised to learn that their effective rate of tax will be significantly lower than the 40 per cent marginal tax rate.

“With a little planning many married couples can look forward to a reasonable standard of living in their retirement with private pension savings starting at €400,000-plus,” says Cree.

A 2021 survey commissioned by life and pensions company Royal London into the barriers surrounding pensions saving in Ireland found 29 per cent of respondents said they plan to start a pension in the future. They might want to reconsider and start today instead.