In the welter of speculation surrounding the proposed State tax-incentivised savings and investment scheme, little or no attention has been paid to what is the most tax-efficient savings and investment proposition you’re ever likely to encounter – your pension.
After all, there is very little not to like about pension saving. Savers can avail of tax relief on pension contributions, or a government top-up in the case of the MyFuture Fund scheme. Plus, tax-free pension growth makes for a competitive proposition.
“Individuals can receive tax relief at either 20 per cent or 40 per cent on contributions to occupational pension schemes and PRSAs, depending on their marginal rate of income tax,” says Davy pensions specialist Claire Nolan,. “For example, for every €100 contributed to a pension, the net cost to a higher-rate taxpayer is €60, as €40 is effectively recovered through tax relief. In addition to this income tax relief, monies invested within pension structures grow tax-free, allowing for potentially greater long-term growth through the benefit of compounding.”
By comparison, Ireland’s auto-enrolment (MyFuture Fund) scheme does not provide traditional income tax relief on employee contributions, she adds. “Instead, employee contributions are matched by the employer, and the State provides an additional contribution equivalent to €1 for every €3 contributed by the employee. This is an equivalent effective tax relief rate of 25 per cent.”
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She points out that this means auto-enrolment may compare favourably for standard rate taxpayers, as the equivalent tax relief rate of 25 per cent is greater than the 20 per cent income tax relief generally available to them on their contributions to occupational schemes or PRSAs.
The tax benefits continue at retirement. “At retirement, you get to take out a lump sum that’s tax-free up to certain limits and at a low tax rate above those limits,” says Munro O’Dwyer, who leads PwC Ireland’s retirement and pensions consulting business.
However, just being a member of an occupational scheme doesn’t mean your pension will provide sufficient income for a comfortable retirement. Pension adequacy has been an issue for a long time. How adequate depends almost entirely on how much you put in over the years.
The good news for members of MyFuture Fund and others with similar contribution levels is that it looks likely to provide an adequate pension. “We’re dealing with pension coverage through auto-enrolment and it is far higher today than it was 12 months ago, so that is fantastic,” says O’Dwyer. “The next step is to ensure that those people who do have a pension arrangement are making sufficient contributions to give them the outcomes they would wish for in retirement.”
Auto-enrolment will eventually go to 14 per cent of salary in total, he says. “That mirrors the Australian system. It has been going for a number of decades, and, at that rate of contribution, it is proving adequate for lots and lots of people as they go into retirement now. Of course, there’s more than just the contributions you pay, there’s the investments that you make and the charges along the way. But in terms of coming up with a number that might put you on track for a healthy outcome, it’s always good to look at other jurisdictions, and once we get to that 14 per cent, which auto-enrolment is going to bring us to over the next decade, people who spend a career at that rate should get adequate pensions.”
Even if contribution levels fall short of that, there may still be time to catch up. “For those who have started saving later in life, it is important to first identify the retirement income you are likely to need and then put a plan in place to achieve it,” says Nolan. “Increasing pension contributions as earnings rise, making full use of employer matching contributions, and taking advantage of tax relief can all help accelerate retirement savings. Additional income, such as bonuses, can in some instances also be used to boost pension funding.”
Regularly reviewing your investment strategy is equally important, as adopting an overly conservative investment approach too early can limit long-term growth potential, she advises. “For business owners, employer pension contributions can be a particularly tax-efficient way of increasing retirement savings, especially where there may be scope to make larger one-off contributions to compensate for a lack of appropriate pension funding in earlier years.”
O’Dwyer points out that increasing contributions as you approach retirement has the additional benefit of reducing disposable income thereby helping to prepare you for the income drop likely to be experienced when you stop working.
People do make mistakes with their pension savings and one of the most common is not having a clear plan, according to Nolan. “Understanding how much income you are likely to need in retirement and developing a strategy to achieve it are fundamental to successful retirement planning.”
Starting too late can also have a significant impact, as it reduces the benefits of compound growth over time, she continues. “Another frequent mistake is failing to maximise employer matching contributions, effectively missing out on valuable additional funding through workplace pension schemes. People should also pay attention to fees and charges, as these can reduce long-term investment returns if left unchecked. In addition, it is important to review investment strategies regularly and ensure that the level of risk remains appropriate for an individual’s age, circumstances and retirement objectives.”
Finally, Nolan advises that pension arrangements should be reviewed periodically, as changes in earnings, personal circumstances, retirement goals or pension legislation may mean that a strategy that was once suitable is no longer the most effective approach.
