Saved Smart… what’s next?

Potential options for a €200,000 Pension

Last month we looked at how you can potentially turn €120,000 of savings into a pot of €200,000. Our sample subject took the advice provided and placed €40,000 of their salary into a pension for 5 years, between the ages of 60-65, to build up a pension of €200,000. They received tax-relief of 40% on these pension contributions. So, what can they now do with their pension savings?

There are different potential retirement options available in what is called an Occupational Pension plan. For the purposes of keeping this simple, I will discuss the retirement options that are available in most pension arrangements. The options for our sample retiree will be as follows:

Value at 65:    €200,000

Tax-Free Lump Sum: 25% of the fund = €50,000

Balance of Funds: €150,000 - can be used to provide a level of income for life in one of the following two ways:

1.    Annuity

You place your €150,000 with a pension company and they pay you a guaranteed income for the rest of your life. At the moment, a 65-year-old may get an income of roughly €5,325 per year (subject to income tax)

The biggest pro of this option is that you are not reliant on fund performance. The biggest drawback is that once you have purchased the pension, you cannot make any changes and once you pass away it ceases.

2.    ARF/AMRF (Approved Retirement Fund / Approved Minimum Retirement Fund)

This is where you reinvest your €150,000 and draw an income out of the proceeds. The biggest benefit is the flexibility (you can take different amounts when you want) and this will pass onto your estate/partner upon your death.

The biggest downside is that you can theoretically draw it all down and/or the fund value does not perform as well to make back what you take out of it.

“I pay income tax on my pension when I retire?!”. This is something I hear from time to time, but remember, you will have had tax relief when you put money into your pension, you gained tax-free growth on your savings, and you received 25% of the fund tax-free at retirement.

Not just that, at retirement you are earning less income, with a sole pension of €150,000 and only the state pension. A lot of individuals (and couples) will pay little to no income tax on their €150,000.

Turn a savings pot of €120,000 on deposit, into €200,000 in 5 years...

Following on from planning for your retirement in last month’s article, I will give an example of how you can really take advantage of tax relief to grow your savings. The following example is theoretically possible for many people, subject to certain revenue guidelines and depending on what pensions you already have accrued.

I will use an example of a person aged 60 who may consider this proposal, for the purpose of this article. They either have no pension savings or are looking to boost their pension pot as much as they can before retirement. I am going to assume they are currently on a salary of €100,000 and are paying 40% income tax on more than €40,000 of their take home income. (for a married couple with one/two salaries, the income tax rate may differ).

Salary subject to 40% Tax Income tax @ 40% Income in pocket

€40,000 €16,000 €24,000

·         In this example I have not included PRSI / USC or any other expenses/benefits, this is just to highlight income tax relief potential.

In this illustration the “income in pocket” portion is the income you will be receiving into your hand after income tax has been deducted.

Say this person has substantial savings on deposit, for example €120,000 sitting in their bank account. We know that €40,000 of their annual income is only worth €24,000 into their hand after they pay income tax.

If you pay into a pension, you get tax relief at your standard rate (you do not pay income tax subject to revenue limits). So, for 5 years, this person could put €40,000 per year from their income into a pension. Their take-home income would decrease by €24,000 but if needed they could subsidize it (if they want) by taking funds from their €120,000 savings (€24,000 x 5 = €120,000).  After 5 years they would end up with a pension pot of €200,000 at 65.

At 65 you could have €200,000 in your pension but since you received €80,000 (€16,000 x 5) in tax relief it only cost you €120,000 to get your pension to €200,000. For a self-employed person, the savings could be even greater as they may have to pay over 50% tax (PRSI/USC) on money drawn down from their company. They may have the option of putting in a company contribution of up to €200,000, which may have only been worth €100,000 in drawn down income.

In the next article I can look at the options you would have with your €200,000 pension.

€100 For Cover That May Only Cost €70???

Our new financial planning system has been hugely successful and popular in assisting clients with setting budgets and plans in place for their future. We try to get people to visualise what they would like to have as a goal, whether it is to pay off a mortgage early, retire early, travel the world or simply provide for family later in life.

Another handy way it can help is to configure whether a person has enough protection in place. Whether it is mortgage protection when purchasing a home or perhaps income protection for a self-employed person, the first question we ask is …how much have you got to spend? This is a great starting point as we can then provide various quotes to accommodate this figure without going over budget before we have even begun!

The following is an example of a quote for Joe Bloggs who is a married, 35-year-old, non-smoker who told us that he has €100 as a monthly budget for his protection needs. In his case, the three main areas he wanted to review was protection for his income, life cover for his family and specified illness cover.

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After we provided Joe with these quotations, we were able to inform him that he can claim tax relief on €75 of this cover at his standard tax rate (20% or 40%). This meant that he could save €15 to €30 a month bringing the total cost (€100) of the cover down to as little as €70 per month.

A Personal Story...

The following is a story of a couple with three children and how they came to review their finances.

“My husband and I had put off any sort of review for numerous reasons. To be honest we didn’t really understand what was involved in a financial review, we had limited funds at the end of each month and didn’t really think about how we would fare financially if something insidious happened to either of us.

We had a life assurance plan that will clear our mortgage if one of us dies and a small life assurance policy with some serious illness cover. We had discussed the importance of starting a pension (for both of us) but had just never gotten around to it. So before proceeding, we decided to get a financial review. For the review we filled out a budgeting form outlining our day to day expenses and including any other relevant information (like our mortgage and any savings or insurance plans we had).

While our initial intentions were to focus primarily on what should go into the pension pots, during the review we got a clear idea of areas we hadn’t considered. The budget showed us how much money we had each month after all our bills had been paid. We were also able to see a visual graph of our income/savings should myself or my partner die or were unable to work long term…which took us by surprise.

We decided on the amounts to put towards our pensions and then asked our broker to work on our other requirements to keep within a budget of €100 per month. We discussed multiple options to try cover our salary and assurance needs within that budget and he was then able to show how this solution would cover us on the same graph shown to us initially.

After the meeting we felt the following queries (relevant to our situation) were addressed;

-       The length of time we would get a wage from our employer before they stop paying us should we be unable to work for a prolonged period.

-       The cost to protect our income.

-       The figure we could afford per month and the best way to utilise it.

I certainly feel that we now have a better understanding of our finances. We have started to put the correct provisions in place for retirement while addressing additional protection needs. This has been like a medical check-up on our financial health.”

What is Automatic Enrolment?

On 30th October the Government approved a large part of a new Automatic Enrolment Retirement Savings System which will supplement the State Pension from 2022. The aim of this process is to improve supplementary pension coverage. Is €248 per week enough for most of us to survive on when we reach retirement?

Who is it for?

• Current and new employees aged between 23 and 60 years of age and earning €20,000 or above per annum across all employments will be automatically enrolled.

• Employees earning below €20,000 per annum and employees aged under 23 and over 60 will be able to ‘opt-in’ to the system.

• Employer contributions will be limited to a qualifying earnings threshold of €75,000 – which will be reviewed over time.

• Employees who are existing members of a pension scheme/contract which meets prescribed minimum standards and contribution levels will not be automatically enrolled.

How will it work for employees?

• Unless an employee is a member of a scheme already, contributions during the first six months of membership will be compulsory. Opt out is available after this time and a refund of contributions.

• A limited number of ‘Savings Suspension periods’ will be facilitated for members who wish to temporarily cease making contributions. Employer and State tax relief will also cease in this scenario.

• Members who opt-out will be automatically re-enrolled after three years but will have the ability to opt-out again under the same circumstances outlined above.

• Employees (rather than employers) will be responsible for selecting a provider and a savings fund option. In the absence of any savings decision, the enrolled employee will be automatically allocated to a default fund. These funds will operate on a Defined Contribution basis.

• Invested funds and scheme membership will follow the member when members change employments.

How will it work for employers?

• Employees will be automatically enrolled with the Central Processing Authority by their employer on commencement of employment.

• Employers will be required to make a matching (tax deductible) contribution on behalf of the employee i.e. at a specified contribution rate.

It is worth noting that the specifics of Auto Enrolment may change between now and 2022. Part of the reason the government are introducing this process is due to the reliance on the state pension. Some people feel there is a chance the state pension will eventually be phased out or will reduce over time for numerous reasons. The question people should ask themselves is, do they want to leave the future of their retirement lifestyle in the hands of future governments or would they prefer to save themselves and retain some element of control.

The Early Bird...

In Ireland, 38 per cent of all working adults don’t have a pension. Of those people that don’t have a pension and don’t ever intend on starting one, 65 per cent plan to live off the State pension when they retire*.

These findings are revealed in Zurich’s latest research into pensions in Ireland. This is the second year of this comprehensive research study and highlights the concerns many people have about their future and how they will maintain their standard of living when they retire.

This year, 53 per cent of those surveyed that don’t have a pension, state that lack of spare money is the reason for it. Of those who have no pension, 31 per cent plan to start saving in one to five years, but more worrying is that 42 per cent think it is too late to start a pension at this stage in their lives.

In 2019, 62 per cent of working adults have a pension. They are contributing €220 on average to their pension scheme each month. Of these, less than half are happy with the size of their personal contribution and 76 per cent would like to be able to save more. According to those surveyed, the average annual income needed to lead a normal life in retirement is €26,747.

Longer life expectancy and working lives might lead some to think that retirement is a long way off, but the sooner you start saving the better. The picture of life in retirement is going to look different for everyone, but it’s worth thinking about what lifestyle you would like, how much that will potentially cost and the income you will need to sustain that.

The message is getting out there that there are tax incentives for people saving into a pension. Almost 60 per cent are aware that everyone who makes pension contributions is entitled to tax relief and 55 per cent know that part of their pension funds can be taken tax-free upon retirement. However, 61 per cent admit that they don’t understand how pension savings are invested, which is up 3 per cent on last year’s figures.

Pensions might seem complicated but they don’t have to be. Engaging with a financial adviser is a good starting point. They can help demystify pensions and investments and get you started on a savings journey that will work for you and planned life in retirement.

You’ve worked for your money, make sure your money is working for you!

Although I believe commissions will remain part of the process on one level, I have been working on a new financial planning service which I will be offering to new clients over the coming months. Many existing clients have found this a very useful and concise tool in setting out a clear plan for their future. I believe this is a prudent exercise, wanting to know how our future will look and getting the most from our money.

Do you ever imagine what you would like to do in retirement or when your mortgage is paid off or even to retire earlier than you thought?

Some questions and comments I regularly hear when I meet people for the first time are:

• I know I should save into a pension, but can you explain why it’s better than saving into a savings plan?

• What will my pension pay me at retirement?

• I am self-employed, can I protect my income if I am unable to work due to illness or injury?

• I have pensions from a previous employment, can I get access to them on any level or what can I do with them?

• I think I have mortgage cover, but I do not know what it does, can you explain it to me?

• Should I pay more towards my mortgage and if so, what change will it have on my term and interest payments?

• I don’t understand how a life assurance policy payment affects me if my partner dies.

• What is the difference between Leaving Service Options and Retirement Options?

Should a person wish to avail of this financial planning service, it involves a simple 3-step process:

1. You will receive a link to a budget planner where you fill in your personal and financial details. This is a comprehensive budget and will take up to an hour to complete.

2. You submit the planner and I review and prepare recommendations and advice.

3. We meet to discuss the results of your budget, your priorities and how you can better manage your money from a savings / pension / life assurance perspective.

Following this, you decide what step to take next. Either way this process will at the very least be an education to anybody who has no current strategy for retirement or savings needs.