Many of us think that pension planning is something that can be put on hold and dealt with at a later date.
Unfortunately, that is not the case, as each payday that goes by without tackling the issue, is one that is costing you money.
Pensions don’t need to be a nasty subject: what if we told you that paying into an appropriate scheme can help you pay less tax now, get you better results on your savings, and will even enable you to receive a whopping tax-free lump sum when you retire?
Now, that we have got your attention, let’s continue…
Retirement may seem like a world away right now, but as time goes by, your future wellbeing will become a growing worry.
Don’t let it be. Fix your pension plan so you can enjoy those golden years.
Do I Need a Pension Fund?
In short, the answer to the above is ‘yes’.
Most experts estimate that you require around half of your pre-pension income in retirement. However, two thirds would be preferable.
You could live a third of your life in retirement, so you don’t want money to be a problem.
Thus, if you are earning €100,000 in your final year of employment, you would need around €50,000 per year for half your pre-retirement wage, or a €66,000 per year income to reach that magical two third mark.
Obviously, this money does not appear out of nowhere, so you have to make a plan.
Many of you know about the state pension and may even be thinking that you can rely upon that for post-work income.
However, as is laid out below, this is well below the average income in the state, so may not be the best option.
The State Pension
The state pension (contributory) is otherwise known as the ‘Old Age Pension’ and is an amount paid to those over the age of 66 dependent on past PRSI contributions.
The maximum you can receive from this is currently €253.30 per week. The average weekly wage in Ireland is over €700 more than that amount.
The disparity between the two figures gives an obvious reason as to why you should start paying into your pension now. Another point is that there has been much discussion regarding the qualifying age for the state pension in recent times.
Thus, if you are at the beginning or middle of your career journey and your only financial plan for your golden years is to live off the state pension, you may have to work beyond the current age of retirement.
Pension Contributions and the Benefits
Pension contributions are long-term saving schemes that allow you to financially prepare for a future where you are no longer employed.
One of the benefits of this type of savings plan is that contributions into it are eligible for tax relief; the maximum tax relieved contribution you can make each year is based off an age-related percentage of your income. Under 30s can contribute 15% of their income and claim tax relief, while for those in their 30s it is 20% and if you are in your 40s, you can get tax relief on a quarter of your annual income. For example, an employee who is aged 45 and earns €40,000 per year can get tax relief on annual pension contributions up to €10,000 – if this individual puts €10,000 into their pension this year, they will save approximately €4,000 in tax – so really it only costs the individual €6,000 to make €10,000 of pension savings
The maximum tax relievable contribution rises to a peak of 40% of gross income for those aged 60 and over. At any age, if you have not made full use of your tax-free contribution amounts in any given tax year, you can catch up or top up your contributions by making what is called an “Additional Voluntary Contribution” or “AVC” for short. Read more in our guide to Additional Voluntary Contributions to Pensions in Ireland.
A common question often asked about the above is “What is the point of making a tax saving on pension contributions now when you just end up paying tax when you go to draw down your pension?”
Our answer to the above is twofold:
- Investment growth and investment income earned inside your pension is received completely tax free inside of your pension. Therefore, the earlier you start saving in your pension, the more time and scope you have for more tax-free investment earnings over the life of your pension.
- Currently, those who are over 65 years old generally pay a much lower overall rate of tax on their income in retirement than they did during their working life. This is due to reduced levels of income, plus exemptions and credits that were not available to them when working. If you are a higher rate taxpayer now during your working life, you can save 40% tax on your contributions now, and in retirement when you are drawing your pension income you may only be paying an overall effective tax rate somewhere in the range of 0 to 15% (depending on your circumstances), plus you get the 25% tax free lump sum when you first draw down your pension pot. Thus, the overall tax saving can be significant.
Check out our handy guide to minimising your tax rate while moving toward retirement for further information regarding this.
All-in-all, the advantages of contributing to your pension are plentiful, but arguably the most important one is the peace of mind you have in knowing you will be secure going into your old age.
How Much Should I Be Pay Into My Pension Fund?
The amount you should pay into your pension fund depends on several different factors.
They include the following:
It is estimated that after 25, every decade you wait doubles the cost of how much you will need to save to have the same amount when you retire.
Which Scheme You Use
As said above, there are several different pension schemes, such as:
Occupational Pension Schemes
Defined Contribution: This is where both you and your employer contribute to your pension savings.
In this case, the employer will often match the contribution of the employee. For example, if you are paying 5% of your salary, they will pay an equal amount to the fund, thus giving you an overall contribution of 10% of your yearly salary – and this is generally entirely tax free.
Defined Benefit (DB): DB schemes don’t calculate contributions, but instead determine pension amounts based on other factors, such as how long you have worked there, or what your salary is at retirement. Defined benefit schemes are rare in today’s world for new employments, they were more regular in the past, and indeed many individuals lucky enough to have a defined benefit scheme are now at the point of approaching retirement.
Personal Pension Schemes & Personal Retirement Savings Account (PRSA):
Popular with self-employed people and those with no access to occupational pension schemes, a personal pension is a pension savings scheme in your name, and approved schemes are eligible for tax relief on contributions.
Is There Anything I Can Do If I Am Behind?
If you are calculating what you will need for your golden years and find that you are behind, don’t fret, as there is a way to make up the additional savings.
Additional Voluntary Contributions (AVCs) allow you to pay a lump sum, which can help bring your overall financial wellbeing back on track.
Check out our guide to pensions for small business owners as well. You may also want to check out this guide if you are considering going for a voluntary redundancy scheme.
The amount any given person should be paying into their pension fund depends on several factors, which include their own personal circumstances, how much they earn and what age they start saving at.
Everyone’s circumstances are different and that should be considered.
Pension schemes are an essential tool creating a better future for you and your loved ones, so consider putting a plan in place now. Future you will be glad you did.