I am genuinely confused about pensions and how they work. I became 65 in December and hope to continue to work until I’m 68.
I have checked and I have full contributions that will allow me 100 per cent of the Irish State pension. At the moment I also have €1.25 million in my private pension funds. When I put these numbers into the pension calculator, it gives me a number that I’d be quite happy with based on my current salary.
What confuses me is: how long will this last? How is it calculated? Is the number I get net of tax? What sort of life expectancy is built into the calculations?
I have been told that I’m better off than most people, but that gives me no comfort whatsoever. I genuinely don’t have a clue how long my pension is expected to last, other than I know my State pension will be paid until I die. My wife, who is retired, has another four years to wait until her State pension kicks in.
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I know we’re not going to go hungry. But I’m still worried, especially when I get a gas bill that’s more than €1,000 for two months, as we just did.
DG
Very few people worry about their pension until it is too late to do anything about it. And when they do get to that age, they really do worry.
It is exactly as you put it. Our earning capacity disappears, or reduces fairly sharply, and we start to consider how we will meet the cost of bills we have taken as routine to that point. It’s rarely a comfortable review.
You mention your gas bill, and energy is certainly one area where costs have risen dramatically in recent years. Figures from the Commission for the Regulation of Utilities last year indicated one in nine households were in arrears on their electricity bills, while almost one in four were behind on their gas bills – and those figures were up on the previous year.
The good news for you is twofold. First, you have very good pension coverage compared with most of those around you. And second, you are asking all the right questions to be able to make the best decisions for your future.
According to some industry sources, the average Irish pension fund in 2024 was about €111,000. Someone turning 65 last year in Ireland is expected to live to about 82.6 years, so that money is expected to last 17½ years. And it could be longer.
I have to tell you, anyone relying on that to see them through the remainder of their life without some fairly dramatic adjustments in their lifestyle is deluded.
A fund of €111,000 will deliver annual income of somewhere between €4,400 and €5,500. If they have a full State pension on top of that, it will add just over €15,500 to their annual income.
That delivers weekly income of just over €400. To put that in context, a minimum wage worker doing 40 hours a week can expect to earn close to €510 a week.
Your private pension pot of €1.25 million is more than 10 times that average and would certainly put you in the league of the more comfortable when it comes to retirement income – the maximum you can have in your pension pot before some fairly swingeing tax hits is €2 million.
Tax-free lump sum
First up, when you retire, you are entitled to take up to 25 per cent of your fund or €200,000, whichever is the lesser, in a tax-free lump sum. This can be spent, saved or reinvested at your discretion.
In a case such as yours, where 25 per cent of the fund is worth more than €200,000, it is worth remembering that you can take out anything between €200,001 and €500,000 (depending on the size of your fund) subject only to the basic 20 per cent rate of income tax.
In your case, with a fund of €1.25 million, you could draw down a lump sum of €312,500. You would pay no tax on the first €200,000 and 20 per cent on the remaining €112,500, or €22,500 in tax.
Given that anything you subsequently draw down from your pension might be at the higher income tax rate, this is certainly worth considering.
Options in retirement
There are three options for you when you retire. You can transfer all the fund to an approved retirement fund (ARF) where it will remain invested – hopefully growing even as you draw it down in retirement. Of course, markets fall as well as rise so there is no guarantee but most ARF policies will be in fairly low-risk investments.
Second, you can buy an annuity – an insurance policy that guarantees to pay out a certain amount to you for the rest of your life. But how much?
The last time I checked – and it certainly took some digging, as annuity providers are cagey in the extreme about releasing their rates – you could get a rate of between 5 per cent and 5.5 per cent for a single life level annuity. You can see the figures here.
Picking the midpoint of that range, 5.25 per cent, the €960,000 left in your pension pot after maxing out your lump-sum option would deliver a single life level annuity of €49,230.
But here’s the thing, a single life annuity covers only you with no provision made for your wife should you predecease her. And a level annuity makes no allowance for the impact of inflation, which can eat into your spending power much more quickly than you expect.
You will get that €49,230 every year for life, with no increase regardless of the rising cost of living.
Make provision for your wife to have a 50 per cent pension if you die before her and, on those 2024 figures, your €49,230 falls to somewhere around €46,405. Build in cover for increases in the consumer price index up to a maximum of 3 per cent a year and your annual payment shrinks sharply – to about €31,875.
You can tailor the annuity in many ways – some people set it up so that it pays out for a minimum of five years regardless of whether you die in the interim, for instance – but every additional variable will lower your annual income.
Of course, you plan to work three more years and that will hopefully boost your pot so the figures will be different. And annuity rates change all the time. I suspect rates currently are somewhat below those I sourced in 2024 and they will be different again when you intend to retire in three years’ time.
Third, there is nothing to stop you doing a bit of both. You can put part of your fund into an annuity to deliver guaranteed baseline income and put the rest into an ARF in the hope of investment gain to stretch that money further.
Back in the day when most people were on a defined-benefit pension, life was much easier – and less stressful. You knew you would get an income for life based on your final salary and the number of years served – a form of annuity, generally inflation-proofed.
But those days are gone and much of the investment risk, both up to retirement and then, if you go for an ARF option, in retirement, now falls on the individual – irrespective of their lack of knowledge in financial planning. That’s partly why people tend to be more concerned about retirement income these days.
On top of the income from your private pension, you qualify for a full State pension, which in today’s money is pennies shy of €300 a week, or €15,600.
You say you fed your salary and pension fund figures into a pension calculator and were quite happy with the number it spit out.
That calculator was the one available on the Pensions Authority website. The figure it throws up presumes that you are buying an annuity and that your pension increases by 2 per cent a year in retirement, is guaranteed for a minimum of 5 years and will give your wife a 50 per cent survivor’s pension if you predecease her.
If you are happy with those numbers, then perhaps an annuity is worth considering.
How long will it last? If you go the annuity route, it lasts for as long as you live. That’s the nature of the insurance contract you would be buying.
If you go for an ARF, it depends on how fast you draw down the income. Assuming you keep working to 68 and assuming you are on a salary of about €100,000 (I have no idea as you did not disclose these details but I am just using the figure for illustration), you could expect to have a pension fund of close to €1.28 million at that stage.
After the lump sum, that would fall to €960,000.
Revenue taxes ARFs on the presumption you draw down at least 4 per cent of the fund per annum up to the age of 70, and 5 per cent thereafter. On that basis, you would have an initial pension of about €38,400, rising to €48,000-odd at 70.
Adding in your State pension, you would have about €54,000 annual income at 68, rising to about €63,500 at 70. When your wife retires, the family income will jump to €69,000, and to €78,500 once you turn 70.
The ARF should last you 20 years on the basis of drawing down those sums each year and assuming no investment growth (or losses) in that time. Clearly, you would hope for modest growth, allowing the fund to last longer. Of course, 5 per cent of a reducing figure also allows the fund survive longer but our living expenses don’t necessarily reduce sharply from what they are once we retire.
Is the number the calculator throws up net of tax? No, it isn’t. The figures – both under annuity and ARF arrangements – are gross income and will be subject to income tax and universal social charge, though not PRSI.
In terms of outgoings, maintaining a standard of living in retirement is based on certain presumptions. Chief among these is that your home is, by that point, mortgage free. This should not be an issue for you but future generations – those now buying their first home in their 40s – could find it becoming a big issue down the line. And, of course, people renting will always see housing costs eating up a chunk of any retirement income.
You are right when you say, compared with the average person, you are unlikely to be in the poor house in retirement, especially given you might well have other savings or assets. The secret to peace of mind, though, is to budget ahead, taking a “best-guess” look at what utility and other household bills you will have, including any memberships, cars, travel plans, etc.
Once this is done, you can adjust your plans if necessary – for instance, deciding that maybe you will only need one, rather than two, cars once neither of you is working.
Assuming you go for the ARF option, planning ahead will also allow you consider the investment options available, noting that you do not have to take out an ARF with the investment house that managed your pension to that point.
And it will also give you a sense of what is possible in the event you face a call on the bank of mum and dad from children looking to get themselves into a home.
Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or by email to dominic.coyle@irishtimes.com with a contact phone number. This column is a reader service and is not intended to replace professional advice
