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Irish Times questions on personal finance

When should I start a pension?

When the time comes to draw down your pension, retirees can opt to take a portion of it as a tax-free lump sum

When the time comes to draw down your pension, retirees can opt to take a portion of it as a tax-free lump sum

 

Remember the old saw about the best time to plant a tree being 20 years ago, and the second best time being today? It’s the same with pensions. Put simply, the earlier you start funding your retirement, the greater your chances of having a significant pot of cash to live on when you retire.

This matters more than ever given the challenges facing the State pension. Right now for every one retired person there are currently six people in employment. By 2050 that could fall to less than two.

What’s more, figures from the Central Statistics Office show just 47per cent of workers have a pension – either a workplace-provided occupational scheme or a personal pension – down from 54 per cent in 2008.

Even without such demographic drivers starting to fund a pension as soon as possible makes sense. For starters, the longer you save for, the more money you will put away.

On top of that, the more years’ worth of savings you accrue, the more you stand to benefit from the joys of compounding, in which interest is calculated on the basis of your growing principal each year.

You also get the benefits of a regime that positively encourages retirement savings, one where maximising your pension contributions can help minimise your tax bill.

This is because, up to Revenue limits, contributions to a pension qualify for relief from income tax. That means that for those who pay income tax at the higher rate of 40per cent , each €100 contribution to your pension will only have a net cost to you of €60. If you hadn’t made that contribution the remaining €40 would have gone to the government in income tax.

And, unlike money in savings or investment accounts that are subject to Dirt tax (39 per cent as of this year), or investments such as shares or properties that are subject to capital gains tax (33 per cent), pension contributions benefit from tax-free growth.

Finally, when the time comes to draw down your pension, retirees can opt to take a portion of it as a tax-free lump sum.

“If you look at pension contributions not in terms of tax or interest reliefs, but purely in terms of return, your €60 is worth €100, that’s equivalent to a 66 per cent rate of return, or 25 per cent return if you are on the lower rate,” says Brendan Barr, head of Investment Solutions at Standard Life Ireland.

“Pensions are obviously a longer term product but if you compare those rates of return with SSIAs [Special Savings Investment Accounts], which everybody understood, you can see the huge benefits of pension savings in terms of rates of return alone.”