Confused? 5 Step Guide to Pensions Made Simple
Will you have enough money to enjoy your retirement or will you be faced with a gap in your funds?
Whether you have a family, whether you’re at home or in employment, a secure financial future will ensure you can enjoy your retirement Have you given pension planning any thought yet? A new online calculator can help you find out if you’ll have a gap in your funds when you retire.
Ireland now has the third largest pension gap in Europe, an average of €12,200 per year per person*. This is the difference between what most people expect to live on in their retirement – and what they currently make provision for. So if you expect to live on €2000 a month, currently an average Irish person is only saving enough to get €1000 a month
Nobody wants to live a ‘recession’ style retirement and planning ahead is the key to financial happiness. Here is a 5 step guide to pensions made simple:
1. What is a Pension?
So what exactly is a pension? When you stop working your pay will stop but all the bills won’t! A pension is the money (usually income) that you will live on when you stop working. It will replace the salary that you earned before retirement and is the most tax-efficient form of saving available.
Provided you are under 75, you can have a pension plan, regardless of whether you are working full-time, part-time or are in casual employment. You can even have a plan if you have no earnings – and are a jobseeker, home-maker or carer. It’s a long-term arrangement, so you can’t dip into it before you retire.
It’s your responsibility to pay contributions into the plan. These are usually monthly amounts but they can be paid less frequently, for example quarterly or yearly, or even as one-off lump sum payments. It’s advisable to ask your employer if the company would be willing to ‘chip in’ also but there is no requirement for them to do so. How much you pay is up to you to decide but if you join a pension plan arranged by your employer there may be a minimum level of contribution.
2. Why Start a Pension Now?
Could you survive on the State pension of €908 a month alone? Healthier lifestyles and advances in medical treatment means that people are now living much longer, so starting a pension now means that your money won’t run out!
Starting a pension now means that your payments can grow tax-free so they have the potential to grow faster than any other types of savings and you’ll be able to continue with your lifestyle and passions knowing that you have put in place plans for the future.
For every euro paid into your chosen plan, the taxman gives 20 cents back and on the higher rate of tax you’ll currently get 40 cents back. If you change jobs you can take your pension plan with you. What’s more – when you retire, you can currently take part of your pension fund as a tax-free lump sum (subject to a lifetime limit of €200,000).
3. Mind the Gap!
So how much do you need to pay in? Aviva has launched a new ‘Mind the Gap’ calculator with figures based on the average extra saving required to provide a retirement income of up to 70% of pre-retirement salary. So what are your potential pension savings gaps?
A 40 year old, saving the current Irish average into their pension could need to save an extra €6,700 per annum. A 50 year old needs to save an extra €9,700 per annum and a 60 year old needs to save an extra €28,000 per annum. This is the difference between what most people expect to live on in their retirement and what they currently make provision for.
4. What are the 3 Big Tax Breaks?
The government wants to encourage everyone to set aside money for their retirement, there are 3 valuable tax breaks available for savers now, whether you have your own pension plan or are in a company pension plan.
The first is tax relief on what you pay in, so for example if you pay €1,000 on the 20% tax rate there’ll be €200 refunded and the net cost to you will be €800. At the 40% tax rate, there’ll be €400 refunded and the cost will be €600 to you.
The second tax advantage is that you’ll achieve freedom from tax on any investment returns achieved by the plan. This is a big advantage, as the value of your plan should build up much more quickly than in a fund that has to pay tax.
The third big tax advantage is the fact that you can take part of your plan’s value as a tax-free cash sum when you retire. You won’t have to pay a cent of tax on it.
5. How and when do I start a pension?
It’s never too late to start a pension but the earlier the better to ensure that you benefit to the maximum. To start the process, an hour with a financial broker is probably one of the most important things you can do. It’s like a health check-up - but for your finances and will help to ensure you have the best possible financial future.
Anybody under the age of 75 can have a pension plan and how much you pay into the pension plan is up to you to decide. The contributions are then invested by the firm – usually an insurance company – that operates the pension plan. When you retire, the accumulated value of your plan will provide you with your retirement benefits – which could be in the form of a monthly income or a lump sum (subject to taxes).
You’ll be allowed to take some of your money as an immediate tax-free cash sum. As a general rule of thumb, most pension experts recommend that people aim to provide themselves with a pension of around two thirds of their annual earnings just before retirement and your financial broker will work out the numbers with you, building in assumptions about when you expect to retire and how your earnings are likely to increase between now and retirement.
You will need to think about inflation however as every euro that you pay into your plan will be worth less in terms of spending power in future years. In terms of providing yourself with any meaningful benefits – the sooner you start the better.
Find out how much you need to put into a pension today to ensure you enjoy the longest holiday of your life. After all, you’ll have worked hard enough for it and your future self will thank you! Go to www.mindthepensiongap.ie.
*Source Aviva, September 2016