A pension is probably the single most important and valuable long-term investment most of us will ever make. But it is also among the least well understood. In a survey carried out by the Central Bank of Ireland last year 61 per cent of people expressed uncertainty or a lack of knowledge in relation to pensions and retirement planning. Just 18 per cent claimed to have a good understanding of the pension products available to them in retirement.
Part of the problem is the timespan involved. The Retirement Living Standards Report produced on behalf of the Pensions Council by KPMG in December estimated the retirement incomes people would require to enjoy a modest, moderate, or comfortable standard of living. They ranged from €19,200 to €33,600 for single people and €28,800 to €43,200 for couples.
But those figures were expressed in today’s terms. People retiring this year at the age of 65 will have gone through three currencies and seen prices increase almost sixfold during their working lives. Asking an individual starting work today to figure out what income they might need in retirement in 40 years’ time or even later is almost an exercise in metaphysics.
Morgan Housel’s book on The Psychology of Money acknowledged the problem. “In the book Housel says that the hardest financial skill is getting the goalpost to stop moving,” says PwC director of pensions and investments Bernard Walsh.
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That perceived difficulty in setting a target may go some way to explaining the quite low rate of supplementary pension coverage. According to the Central Statistics Office (CSO) more than 40 per cent of private-sector workers in Ireland have no supplementary pension arrangements and will be solely dependent on the State pension for their income in retirement.
“The amount of retirement income you need varies based on your lifestyle expectations,” says Marta Pelc, pensions adviser with Cantor Fitzgerald Ireland. “Your spending habits significantly influence how much funding you’ll require for a comfortable retirement. Additionally, it’s crucial to consider other potential income streams during retirement, such as investment or rental income. Maximising your eligibility for the State pension is also a key factor.”
According to Pelc, you can determine your eligibility for the state pension through either the average rule or the total contributions approach (TCA). “To receive the maximum payment under TCA, you must have a total of 2,080 PRSI contributions, which equates to 40 years of contributions. Home caring periods are available for the time spent caring for children under the age of 12 or for an incapacitated person, allowing for a maximum of 20 years to be included in the calculation. If you plan to retire before reaching the state pension age of 66, consider making voluntary PRSI contributions after retirement to qualify for a higher state pension than you might ordinarily receive.”
Once you’ve determined your state pension eligibility, it’s time to look at what additional income you need. Ashling O’Neill, a certified financial planner with Clear Financial, explains that is not absolutely necessary to estimate what will be required decades into the future.
“You can only look at it in today’s terms, you don’t know what inflation will be like and so on. You know if you work for 40 years you’ll qualify for the State pension. That’s about €1,200 a month at the moment. If you look at the Retirement Living Standards Report, a moderate retirement income is about €2,500 to €3,000 a month. If a person retires at 66 with a state pension of €1,200 a month, they will have a shortfall of €1,500 to make up if their target is €2,700 a month, for example.”
That’s the target – a fund that will generate growth of €1,500 a month in today’s terms. “You need to have enough in your fund to ensure that its growth is replacing the money you’re taking out,” says O’Neill. “That will make sure your fund doesn’t run out over the years. People normally take out between 4 and 5 per cent of their fund every year. You don’t want it to have to grow by 10 per cent every year – that would represent too high a risk.”
Based on 5 per cent growth and drawdown, that equates to a €360,000 fund to generate €1,500 a month. And €500,000 when you allow for a €140,000 lump sum that the individual might wish to take on retirement.
Getting there is the next step. “If you’re starting at 40 years of age and planning to retire at 65 and assuming growth rates of 5 per cent per annum you would need to contribute €800 per month,” says O’Neill. “That’s €500 after tax if the person isn’t in an occupational scheme. And if you increase contributions in line with inflation each year, that will help to ensure the final amount also increases in line with inflation.”
Starting earlier can make a big difference, she adds. “For a 35-year-old, the contribution reduces to €600 per month or €360 after tax and for a 30-year-old it’s €440 or €264 after tax. The earlier you start, the cheaper it is to achieve your target.”
“We try to get through to people that the earlier you start, the more your money works for you,” says Bank of Ireland head of financial wellbeing Dawn Bailey. “It’s the glory of compounding. If you start in your mid-20s your money will do so much more for you than it will in your mid-40s. The hardest thing is to start, but once people start, they tend not to stop. What you don’t have, you don’t miss.”
She also advises people to increase their contributions over time. “If you get a salary increase or bonus you should consider putting half of it into the pension and the other half into an emergency fund or other savings. And if your employer makes matching contributions, you really are quids in.”
Pelc agrees: “If you have the choice between a salary increase or a higher employer pension contribution, it may be wiser to choose the latter. For example, a €1,000 pay rise might result in approximately €480 after tax for a higher-rate taxpayer, while a €1,000 employer pension contribution goes directly into your pension fund.”
There are other steps people can take to maximise their pension. “People are no longer in the same job for life,” says Bailey. “They might have pots from old jobs collecting dust. They should look at consolidating them to avoid some of the fees.”
The introduction of the national auto-enrolment pension scheme later this year will do much to address the low rate of pension coverage. To be known as My Future Fund, the scheme will automatically enrol workers aged between 23 and 60 and earning more than €20,000 a year. Employees will contribute 1.5 per cent of their salary, with employers matching it. The State will top it up by one third of the employee contribution. Contribution rates will rise to 6 per cent and 6 per cent with a State top-up of 2 per cent after 10 years. Employees will be able to opt out after six months but will be re-enrolled every two years after each opt-out.
“Auto-enrolment serves as a solid starting point for retirement savings; however, it’s essential to take proactive measures to ensure your savings will meet your future needs,” says Pelc. “Based on the proposed contribution levels of 14 per cent after 10 years of employment, many employees may not accumulate enough funding in their pensions to retire comfortably.”
Bailey looks on the bright side. “Having something is better than nothing. My hope is that it will create a much broader national conversation around pensions. It might prompt more people to start thinking about maximising retirement income. But there are some shortcomings. You can’t take your pension early, for example. People have to think about that. But it will be brilliant to have more people on the pension journey. That can only be a good thing.”
