I don’t Believe in Pensions. (I am told so often)
I have heard this so many times. My business is my pension. Why should I pay a fee to save my own money? I save any way why is a pension better? These are all things I have heard people say when the subject of pensions is raised.
There are 2 primary reasons people misunderstand pensions and they are rooted partially in the way pensions are sold and stories of people whose pension experience has been blighted by poor decisions.
There are 2 decisions when considering a pension.
Decision 1 is do I want to save in the most tax-efficient way possible so that I can live my best life possible when I stop working?
Decision 2 what return do I require from my pension savings to fund a suitable income for my needs when I decide to stop working?
These are two clear and separate decisions. The example below illustrates this.
Now let us suppose……….
You have got to the end of the year and there is €6,000 left in either your company or business current account.
Choice 1 you take it out directly into your own hands i.e., as income and then save this for your future.
Assuming a marginal rate of 27% tax, PRSI and USC you will have €4,380 left.
If you do this every year for 20 years you will have €87,600.
And if you invest in a deposit and get 0.5% (Not available today) you will have in 20 years €88,017.
Now let us suppose the €6,000 is contributed to a pension. You can do this because the pension contribution is not subject to tax. If your pension, then makes no investment and we assume the pension fees are 0.5% you will have a fund of €114,467.42 after 20 years to draw income from.
You can already see that just saving into a pension results in an increase of €27,000 because of the tax relief alone.
However, there are 2 tax savings you benefit from whilst you contribute to a pension. If you have a return on your pension savings this return is also tax-free until you draw an income. That means that it will not be subject to DIRT, Capital Gains Tax, or Exit tax whilst the funds remain in your pension.
If the pension now generates a return of 0.5% (Again not available on deposit today) your fund will be worth €120,000 in 20 years. This means that the pension saving advantage has now grown to €32,000.
This tax advantage for pension savings is more pronounced if you do invest. Using the examples above if you invest the after-tax €4,380 in a fund and earn 3% per annum you will have €103,129.10 in 20 years after tax is deducted.
If you save the €6,000 into a pension that invests in a fund and generates a return of 3% per annum you will have a fund of €161,222 in 20 years to draw your pension from.
The difference now is €57,000.
The problem is that pensions have been promoted as investment vehicles because that is where the money is for the financial services industry. People become confused when they are told that they must invest in their pension. The perception of investments is risk and in general, people do not like risk.
Pensions should be savings programs with the sole purpose of providing a source of income when you choose to stop working. Yes, there may be a need to invest but your investment approach should be taken as an independent decision.
A good starting point is to figure out how much is your enough? By this I mean what income will you require to live your best life possible when you stop working. For many of us, this is no easy task. My advice is that you talk to a Certified Financial Planner Professional. They have been trained to consider exactly this question for you. They will also help with the many big financial decisions that you may have to make throughout your lifetime. A CFP® will work with you to develop your financial plan considering all your circumstances. They will make financial decision-making less about emotional choices and more about fact-based ones. They will then help you implement any choices that you have made and be by your side as you navigate through your financial life.
