Make the most of your money

First, the very good news. You are likely to live a lot longer than your grandparents. Thanks to medical advances and increased awareness about living a healthy lifestyle, we are set to live a lot longer than previous generations – at least a decade, in fact. A person who retires at 65 now can expect to live for more than 20 years. And the news for children born in the 21st century is even better again.

While this longevity is worth cheering about, it does have a financial downside: it is putting pressure on pensions that would have been unimaginable 30 years ago.

Our good health is not the only reason pensions have been ailing of late.

We are living through some of the worst economic turbulence in the history of the State with hundreds of thousands of people living day-to-day and struggling to set cash aside for the weekend never mind their long-term future.

This means that too many are putting saving for their retirement on the back burner.

While this is understandable it is wrongheaded. Pensions matter and they matter now more than ever.

They are something that everyone needs to think about. If you haven’t started one already then start one now. Even if you have started one, you should start to save more.

“People use the first phase of their life preparing for the second phase through education,” says Maura Howe of the Pensions Board.

“But if they don’t use the second phase to prepare for the third by investing in the future financial security, the last 20 or so years could be very hard.”

State pension
The State pension stands at about €12,000 a year. According to repeated polls carried out by the Pensions Board, 80 per cent of us say we would struggle to get by on the €230 a week the State pays.

But less than 50 per cent of those polled have private pensions, which leaves a lot of people staring into a financial abyss when they retire.

So what to do? And how much does someone need? The National Pension Policy Initiative in 1998 said that adequate gross retirement income was about 50 per cent of gross pre-retirement income, a figure that includes the State pension.

So if you earn €80,000 today you will need a pension income of €40,000. If €12,000 comes from the State, you need to find €28,000.

That is not as little as it sounds. To reach the €28,000, you will need a fund of between €700,000 and €930,000. To get that a 35-year-old would need to put aside €1,000 every month for the rest of their working life.

There are not many people who could manage that. But if you can’t, you should be able to manage something.

It will make a difference and the sooner you start the less painful it will be.

A 30-year-old who wants to fund a private pension that returns just €8,000 a year when they retire at 68 years will need to make monthly contributions of about €120.

If they wait until 45, that monthly figure will jump to €285 a month.

Additional Voluntary Contributions (AVCs) are all-too-frequently overlooked but are a fabulously turbo-charged way to get your pension moving.

Apart from anything else a pension top-up allows you to watch compound interest work in a very pleasing way.

Assuming growth of 6 per cent per year and a 1 per cent annual management charge, if you saved an extra €200 per month in AVCs, your fund would grow to €162,000 after 30 years. This money is in addition to your main scheme.

Compound interest
"Pensions are a compounded product so the key is to start early and then watch them grow," Howe says.

She believes if people could actually watch their pension pot growing in real terms as opposed to obtuse percentages it would focus minds and encourage more people to invest.

The clever Swedes already have this sussed. The pension system there allows everyone to see how their money is growing from month to month online. So this can help to incentivise them.

“Look how many people signed up to the SSIA [special savings incentive account] schemes a few years ago,” Howe says.

“That was because people could see what the returns were and when they were coming. But the reality is that many pensions offer better returns than the SSIA ever did so what we need to do is communicate that fact more clearly and help people to see the benefits of pensions in a real way.”

Sandra Rockett of Davy says young people need to be shown the importance of discipline when it comes to pensions.

“People’s expenditure tends to grow to fit their income and that can be a very hard habit to break. So if they develop the discipline of putting money aside early then that is a habit that does not need to be broken,” she says.

She stresses the tax efficiencies of the pension. If you earn €1,000, the Government helps itself to €550 of it almost immediately – and more in the form of non-direct taxes. But if you put that into a pension, over €900 of it goes into your fund and it gives you tax-free growth, which is relief on the double.

Bad rap
Pensions funds have had got a bad rap in the press in recent times with much talk of shortfalls and schemes being wound down.

They have deserved it.

“The impact of the recent economic turbulence on Irish pension schemes has been well documented,” says Patrick McKenna of Mercer. The issues around pensions on deficits are part of global phenomenon in developed market economies. This has forced pension funds “into action to try to control the size and volatility of these deficits”.

He says some have limited their exposure to future deficits by closing defined-benefit pension schemes while other pension schemes have moved away from investment strategies that were largely equity-based in favour of lower risk asset classes such as bonds.

But despite the turmoil and the more sedate, safer investment paths, pension funds still beat inflation and money on deposit. If you saved €200 a year or €72,000 over the past 30 years in an average pension managed fund you would have a fund of about €300,000 today. And some investments are doing better than others.

So what risks are appropriate? Well it all depends on your age.

The older you are, the more cautious you should be. If you are young, higher-risk funds are appropriate.

The key is to put your eggs into different baskets. To save yourself a headache look towards funds that have a dynamic aspect where they de-risk you as time passes.

Consider these because although your pension is a market investment, few people look at their ‘performance’ regularly the way they might with privately held stocks.