All you need to know to ensure a comfortable retirement, from tax relief to AVCs
This article was published in The Irish Times, February 2021
If you’ve been spending lockdown cleaning out your presses or watching too much television, perhaps you could also consider using the time to give your pension a little TLC.
Much advice on pensions is focused on working out how much we hope to retire on: the reality for so many of us is we’ll have to make do with whatever we end up with. Working towards a specific goal is simply unaffordable. But rather than be completely defeatist, taking some small steps can reap dividends over the long term
Take an overall view
To do: Track down old pensions
It may have been on the long finger for years, but take the time now to collate the details on any pension funds you may have with former employers, and get log-in details so you can check the balance/performance. And if you’ve recently joined a new employer, find out about their pension scheme – now.
“People shouldn’t wait for it; if they have the opportunity to join an employer-sponsored arrangement, they should seriously consider it,” says Shane O’Farrell, Head of Products with Irish Life.
If you want to bring this a step further, over the coming weeks we’ll be taking a look at whether or not you should keep these pensions separate or consolidate them.
Stop leaving ‘free money’ on the table
To do: Check with HR for your company’s contribution policy
It’s clearly a no-brainer and yet so many of us never do this – topping up our pension contributions to make sure we get the maximum contribution from our employer.
Many employers offer their employees a certain proportion of their salary towards their pension each year, but this is often dependent on how much the employee themselves contribute.
A typical employer contribution is of the order of 6-7 per cent: some employers will pay more and others less. To get a retirement income of about half your salary, advisers typically suggest that you should be saving at least 15 per cent and ideally 20 per cent of your salary towards your pension. That is far beyond the reach of most of us, which is where your employer hopefully comes in, to help beef up those contributions. But to get, for example, the full 7 per cent your employer is offering to pay into your pension, they might require you to contribute 5 per cent, and this is something many people will simply not be aware of.
O’Farrell says that a problem can be where the default contribution option is pitched at a certain level, often in the middle. So you might pay 3 per cent and your employer add 4 per cent, even though the maximum they will pay is 7 per cent.
“People accept the default as the ‘approved’ or ‘recommended’ level, and don’t tend to pitch up from there,” he says. But when the default is set at a higher level, people tend to stick with it more.
Forgoing your employer’s pension contributions is akin to giving up “free money”, says O’Farrell, who adds that when tax relief and investment growth is added, employees may get a quadrupling of their contributions over the period.
Consider an employee earning €50,000 putting 3 per cent of salary into their pension, with a further 5 per cent from their employer. This comes to annual contributions of €4,000 a year, but is only costing the employee €900 a year, once tax relief at the higher rate is factored in.
If they upped their contribution to 5 per cent of salary, their employee might offer 8 per cent. So now they have €6,500 going into their pension fund – and it’s only costing them €1,500 a year, or €125 a month. So they’re getting an extra €2,500 a year in contributions but it’s only costing them an extra €600.
Maybe that extra 1 per cent of gross salary will be simply unaffordable for you this year; but at least if you know about it, you may remember to up your contributions in the future when you’re in a position to do so.
Maximise tax relief
To do: Check age-related rules
It’s the major advantage of investing in a pension; every €100 you invest will only cost you €60 if you’re a higher rate taxpayer, and €80 if you pay tax at the standard rate. This is thanks to tax relief on your contributions. But did you know this relief is only available up to a certain amount?
“There is generous tax relief out there and people may not be aware of that,” says O’Farrell.
If you’re under 30, you can only claim tax relief on 15 per cent of your net earnings, rising to 20 per cent between the ages of 30 and 39. From 40-49 you can get relief on contributions of up to 25 per cent of your pay. This rises again to 30 per cent from 50-54 and 35 per cent up to the age of 59. Relief on up to 40 per cent is available for those aged 60 and over.
There is also a separate overall limit of €115,000. This is the upper limit against which the percentages can be applied. If you earn more, you can only get relief on the percentage of that figure that your age determines.
If you’re relatively young, you’re unlikely to get exercised by these limits, as you will likely have several other demands on your finances, such as getting a home, renovating it, or starting a family.
In your 50s and 60s, however, if you take advantage of the tax relief available, you can really add some rocket fuel to your pension savings.
On earnings of 50,000, a 30 year old could contribute €7,500 a year (€625 a month) and benefit from full tax relief, rising to €20,000 (€1,666 a month) for a 60 year old.
Consider AVCs
To do: Think about the best use for any spare cash you may have
If you’re already top of the class when it comes to your contributions, you may realise from the above that you are leaving tax relief on the table. Even with employer contributions of 13 per cent of salary, our aforementioned 30-year-old is still only using about about a quarter of the tax relief available to them, because the employers’ contribution does not count towards individuals’ age-related contribution limits.
This means our 30-year-old could put an additional 15 per cent of salary, or €7,500 a year, into their pension. And doing so would only cost them €3,500 thanks to tax relief.
And the way to do it is via additional voluntary contributions (AVCs).
Some advisers suggest that every time you get a pay rise, you put a proportion in your AVCs – after all, you never used to have it, so why get used to spending it? The caveat here is that you may be better off putting any spare cash you have towards paying down debt, such as a mortgage.
Start thinking about your retirement
To do: Think about what’s best, an annuity or ARF?
If you’re in your 50s, this is a question you should be increasingly considering. While it’s all very well being a top saver during your working years, you also need to work out a strategy for retirement. And key to this is working out how to structure your pension fund.
If you think you’re going to opt for an approved retirement fund (ARF), which means that your pension stays invested into retirement, you may need a different investment strategy in the years approaching retirement.
With an annuity, on the other hand, your fund is in effect sold to pay for a guaranteed income in retirement, which means that you may need to sell out of riskier assets when approaching your retirement date. In years gone by, annuities, which are compulsory for those who have defined benefit/final salary pensions, were the most popular choice in retirement, as they pay a guaranteed income and you don’t need to think about them once you buy one. However, with interest rates on the floor, they are currently poor value.
“It is much rarer to see people going down that road [now],” says Andrew Fahy, head of tax and financial planning with Brewin Dolphin.
The advantage of an ARF is that it can continue to grow into retirement – and sometimes beyond.
“The really important point is the money doesn’t die with the individual; it is a fund to be passed on,” says Fahy, adding that he thinks pension savers should see this fund as a family asset. “People are seeing the pension fund as an asset on the family balance sheet, and not just to provide income,” he says, adding, “for a lot of families it’s the biggest asset that they have, even bigger than their home”. A key advantage with an ARF is that should one spouse die, “the survivor steps into the shoes of the original ARF holder” and thus the assets are protected. With an annuity, on the other hand, while there may be some continuation for the surviving spouse, it’s likely to pay out at a lower level.
“And with the second death, it’s gone,” says Fahy. With an ARF however, it can be passed on to the children, although a flat 30 per cent tax is taken off the top.
In addition, as Fahy notes, opting for an ARF when you’re 65 does not mean you have to stick with it when you’re 75. “You can always use the proceeds to buy an annuity after the fact, which is important from a flexibility perspective,” he says.
Pension savers should also watch out for proposed Government-led changes to pension structures in Ireland. If implemented, ARFs will be replaced by a whole-of-life PRSA, which could affect how they might be treated for inheritance purposes.
