Pensions a Beginner’s guide

Tommy Byrne, FCCA, QFA


It’s time to talk about Pensions


First of all, pension is not a dirty word. I think pensions have to be marketed differently, as the public perception of pensions is debilitating for society as a whole. At present, in Ireland, we currently have 5.5:1 ratio of taxpayers to old age pension recipients. This ratio is to drop to 3:1 tax payers to old age pension recipients. Ireland is a small island nation and because we now have an ageing population the social cost to the Irish Government will only continue to rise. At present the maximum state contributory pension is €12,911 p.a. and the ability of the Irish state to continue increasing the funding for pensions is dwindling. In response to this the Government have put the onus on individuals and employers to make provisions for income in retirement.

Reality of the “Pensions Cliff”

The reality of the situation is most individuals cannot survive on €12,911 p.a. old age pension. Think of your current wage now and then all of a sudden having to drop to €12,911 p.a. Now think of how you are going to survive on that wage for another 20, 30 maybe even 40 years. If you elaborate further on this point, you may have an ambition to retire early in life at 60 and have not made any provision for how you will make up the difference in earnings until you reach retirement age, which is currently 67. This is why pensions are so important.

Marketing: Think of Pensions as Retirement Planning

You might ask why I think that pensions need to be marketed differently and my most common answer would be “the bike to work scheme”. This is usually met with confused looks in my direction. However, if you look at the bike to work scheme it is actually administered in the EXACT SAME WAY as to how a pension is administered. You pay up to €1,000 for a bike or equipment and you get up to 40% back in a refund from the government. Now think of all the people who spent the full €1,000 just so they would get back €400 from the government with a state-of-the-art bike rusting in their garage at the minute! Just like the bike to work scheme your pension contributions could receive up to 40% refunds from the Irish government but unlike the bike to work scheme you will derive far greater benefit from having a pension arrangement in place.

Let’s talk Tax Relief

As with the above point on marketing not only do you get up to a 40% tax refund on pension contributions the amount invested in a pension fund continues to grow tax free until you take your lump sum. There will be no Capital Gains Tax or Deposit Interest Retention tax charged on any gain made by your pension fund. If you have a pension fund of €100,000 and it grows by €10,000 to €110,000 that is your money nothing will be taken from it. If you personally invested money as in the scenario above your €10,000 gain would be reduced by Capital Gains Tax (CGT) 33% or Deposit Interest Retention Tax (DIRT) of 41%.  Reducing your gain to €6,660 or €5,900 respectively.

And even more tax relief: The Tax-Free Lump Sum

The Tax relief doesn’t end there. When you come to take your tax-free lump sum you are able to take a tax-free lump sum of 25% of your entire pension fund up to a limit of €200,000. The next €300,000 is subject to tax at 20% standard rate of tax. This is still extremely good from the point of view of a 40% rate of tax employee as tax paid will be less than half of what it should be as the marginal rate of tax would be 51%.

When to start a Pension?

Although it is very true that the earlier you start a pension the better it will be, because you can avail of up to 40% of refunds on your pension contributions there is really never a bad time to start. People in older age groups can still benefit significantly from starting a pension later in life. My advice is the same to all people no matter what age they are, just make a start, get the habit going and it becomes second nature.

Compound Interest

It is better to start earlier in a pension for the simple reason of compound interest. If you put €1,000 into a pension fund at 26 and your fund grows by 5% that year. You now have €1,050 euro. The next year your fund grows another 5% your base fund grows to €1102.50. The return is added to the current value of the fund not just what you originally invested, all the while you are constantly adding to your pension pot month on month but for handiness sake let’s just say you contribute €1,000 per annum. Over 34 years you will now have a fund of €90,320 without really trying. Furthermore, you would have only paid €34,000 gross to get this pension pot. You will have also received up to 40% or €13,600 back from the government in tax refunds on your contributions.

Revenue Contribution Limits

It is never too late to start a pension due to revenue rules on how to pay into a pension. You are allowed to contribute more of your Net Relevant Earnings into a pension the older you get for the specific reason to enable people to make up for lost time when they did not make any pension contributions in their 20’s, 30’s or 40’s to enable them to generate retirement savings to serve them into the future.

Selection of funds

All life companies have a vast selection of funds available to choose from. But where a broker will actually start from is by identifying what risk is attributable to each individual client. The ESMA scale was designed to give guidance on the risk appetite of clients when providing them with advice on funds. The scale ranges from 1-7 with 1 being a totally risk adverse individual to a 7 who is an individual that likes to live life on the risky side. In order to know where you stand on the scale all investors are required to provide answers to a risk profile questionnaire. Once we have received this questionnaire, we will be able to advise you on what risk profile you are and what fund is appropriate for you. For instance, if you came out as a 3/7 we can therefore only advise you on funds that are rated 3 on the ESMA scale.

Regular Reviews

Now that you pension is up and running it is key to regularly review it with your financial adviser to ensure that the fund is performing well, that your risk profile is accurately reflected in your fund choices. That fees applied on your pension are still competitive with other pension providers. Most importantly to decide where you would like to see your pension progress to in the years ahead.