The single best investment that most people can ever make is a pension. Not only do they get tax relief on their contributions, but they also enjoy tax-free growth in their pension fund.
“Pensions are essentially long-term savings plans with extra tax advantages, and that’s exactly what makes them so powerful,” says Niamh O’Connor, a financial planning specialist with AIB in Cork.
“First, you get tax relief on contributions, which can reduce the actual cost of saving significantly. For someone paying higher-rate income tax, a €100 pension contribution effectively costs just €60 after tax relief. Second, any growth within the pension, from interest, dividends or capital gains, is tax free. Finally, when you retire you can usually take a portion of your pension pot as a tax-free lump sum. These advantages mean pensions are one of the most efficient ways to build wealth over time.”
And there’s more. “Often an employer will also contribute to an employee’s’ pension fund, particularly where that employee is making personal contributions,” says Alison McHugh, partner and head of private client services at EY Ireland. “For employer contributions to an occupational pension scheme, tax relief at up to 52 per cent is available because employer pension contributions are generally exempt from income tax, PRSI and USC, whereas personal contributions qualify for income-tax relief only.”
RM Block
Despite those benefits, pensions coverage remains stubbornly low. According to the CSO, about 800,000 workers in the State have no supplementary pension coverage, while a survey carried out by Ask Acorn during the summer found that 30 per cent of Irish adults have no pension savings whatsoever. That same survey also found that the average pension pot of an Irish adult is just €80,570.
“There are many reasons for low pension coverage in Ireland,” says Fergus Moyles, head of private wealth strategy at Mercer Ireland. “Firstly, we have to acknowledge the difficulties many people face while trying to cope with rent, house prices and the general cost of living. Many individuals struggle to get by month to month, particularly earlier in their career, so they put pension saving on the long finger.
“Secondly, as things stand, although all employers have to provide access to a pension scheme, they do not have to contribute towards one. So, many employees do not benefit from employer contributions into a pension. Employees are often more likely to be incentivised to save for their pension if they are getting the benefit of both tax relief and employer contributions.”
Unfortunately, the impact of a delay in starting a pension is amplified through missing out on compound growth. O’Connor emphasises the importance of starting early. “Simply put, the earlier you start, the bigger the difference compounding can make,” she says. “Even small contributions in your 20s or 30s have decades to grow. Add in the tax relief on contributions and the boost from employer payments, and pensions are one of the most efficient savings vehicles available.”
Opting out of an employer pension scheme often means missing out on valuable employer contributions that are designed to boost your retirement savings, she adds. “As your income grows, increasing your contributions ensures your pension grows with you.”
Fergus Moyles explains the impact of a delay. “Consider someone earning €40,000 per annum who starts a pension at age 45 and contributes 5 per cent while getting another 5 per cent from their employer. Assuming 5 per cent investment growth and 2 per cent salary growth, they might expect a pot of around €161,000 at age 65. If that same person started when they were 25 and earning €30,000 per annum, their fund could be worth around €495,000 at retirement.”
Elkstone co-founder and chief executive Alan Merriman has an interesting view on this. While acknowledging how immediate financial pressures such as saving for a home can cause people to put off starting a pension, he believes people still have a choice.
“For the younger generation it might be smarter to provide for a pension first and then look at housing later,” he says. “This fits in with people marrying later and starting families later in life. This way, they will benefit from compound growth on their pension savings for longer. They can always dial down their pension contributions later as their needs change. If they can allocate a percentage of their net pay to pension savings early on and, as their salary goes up, allocate more of the increments in salary over time that would be very valuable. I would definitely encourage people to think along those lines.”
Ashling O’Neill, a certified financial planner with Clear Financial, agrees. “It’s all about time,” she says. “The main reason why people delay is affordability. Finding a good financial planner who can go through these things with you is important. People might say they can only put in €50 a month and think that’s not enough. But with compound interest it builds up over time and you can always increase it when you can afford to.”
Late starters still have options, however. “There are things you can do to maximise your pension savings; you should maximise your capacity to make personal pension contributions through your employment,” says McHugh. “In some cases, the level of employer contributions may be linked to the level of employee contributions and so the benefits of maximising your employee contribution will be twofold. For a lot of employees there may be a cap on the level of regular pension payments that can be made via payroll. However, there may be scope to make additional voluntary contributions (AVCs) to maximise pension contributions and related tax relief.”
According to O’Neill, a change in mindset can also make a big difference for late starters. Lack of access to pension savings until retirement is often seen as a blocker to pension savings, but that is not so much of an issue for people in their mid-50s who will be retiring in the next 10 years or so. Instead of viewing it as a pension, they should see it as a very attractive savings instrument.
“They can almost see the end of the tunnel,” says O’Neill. “The combination of tax relief on contributions and tax-free growth is unbeatable when you compare it to other savings plans. It’s never too late for people to do it.”
