FDC: A pension plan is easiest money that you’ll ever make

LIKE that dental appointment you keep forgetting to make, pension plans often get swept under the carpet will all that other mundane ‘stuff’ we really ought to deal with instead of ignoring.

As the annual pensions season rolls around talk turns once again to the pension deficit, retirement age to qualify for the State pension and auto-enrolment … have I lost you yet?

But what if I told you that a pension plan will earn you the easiest money you’ll ever make? This is in fact true, for a number of reasons.

All gains and income from pension investments are tax-free while in the pension. This tax-free growth is an advantage often overlooked as people tend to focus on the tax relief on contributions.

In contrast, investment gains are taxed highly in Ireland, at either 41% for funds and exchange-traded funds (ETFs), or 33% for stocks and property. Income from stocks and property is also taxed at income tax rates.

Also, investors have flexibility in how they invest their pensions and are not restricted to standard ‘off the shelf’ pension company funds.

Also, employer pension contributions are the most tax-efficient investment available. Many people undervalue this when negotiating new employment contracts. In some cases, particularly for high earners, a lower salary and higher company pension contribution would be much more beneficial.

Pensions are incredibly good value now. Contracts on the Irish market start from as low as 0.5% per annum. To put that in perspective, that is €500 per €100,000 for the pension structure, investment funds, online access to view accounts and customer support from the provider (it doesn’t include the cost of advice).

It is a neurological fact that our brains find it difficult to imagine our future selves which can make it challenging to plan and invest in the future.

According 2020 CSO figures 64.7% of the population have pension coverage of some form (outside of the State pension) which is an increase of almost five percentage points on the same period in 2019.

But most of these are well under-funded and will need to be reviewed urgently to make a real difference to people in retirement.

Pension coverage is lowest among younger age groups with as few as one in four 20-25 year-olds contributing to a pension scheme.

However, there is a cohort of younger investors with an interest in the markets who are keen to open online trading accounts.

They’re often unaware that they can do the same within a pension structure, either through a stockbroker, or the self invested option available through a life assurance company. This can be a much smarter move in terms of the rate of return and tax benefits to be gained.

Younger investors are also keen, and rightly so, to invest in ethical, sustainable businesses. This is the fastest growing investment sector, and most investment managers are focused on aligning their product portfolio with environmental, social, governance (ESG) criteria.

The decision has finally been made that the State pension age is to stay at 66 and will not increase. The commission had recommended that pensions should automatically rise each year in tandem with wages and prices.

We don’t know if the final plan will have anything to say about this, but it is a vital point. Otherwise, it is up to the Minister for Finance each year in the Budget.

The Pensions Commission also recommended that a way be allowed for people to retire at the original retirement age of 65, but with a slightly reduced State pension.

For example, this might mean retiring at 66 on the main pension level, currently €253.30, or going a year early and getting a pension of possibly around €240. This would be better than the transitional arrangements which currently apply for people who retire at 65, and for people who wish to work longer these falls into two camps.

First there are people who, by age 66, have not worked long enough to qualify for a full pension but would currently get a reduced amount.

It looks like they will, if they want to, be allowed to defer drawing down their pension, work on up to a maximum age of 70, continue paying PRSI and thus increase the level of their pension entitlement.

The second group of 66-year-olds are those who have already worked long enough to qualify for a full State pension.

Under a plan put forward by Social Protection Minister Heather Humphreys, these people would be able to choose to defer drawing down their pension at age 66, continue to work and pay PRSI and qualify for a slightly higher pension when they do retire.

While the Pensions Commission suggested this could be done on a cost-neutral basis, there are understood to be concerns in the Department of Public Expenditure and some other arms of government about this and it has not yet been agreed. Having a range of different pension rates would also be complicated and could lead to political pressure in time to pay higher levels across the board. So, we will have to wait and see.

If it does happen, the Pension Commission suggested that the annual increase a person beyond 66 might expect would be in the region of 4% per annum. So, taking current payment rates, the choice might be to retire at 66 at a rate of €253.30 or retire at 67 on a pension of around €10 higher — €263. Higher rates would then apply at older age levels up to 70.

So, my advice is to take it step by step and seek the advice of a broker.

Completing the application forms and setting up a direct debit is a big step for many but it’s the most important one – you’ve started. And the benefit of growth over time will hopefully act as an incentive to contribute more when you can.

The good news is, it’s never too late to start, as the tax relief alone makes it a very good investment option, even if the final pension provided is small.

Do your future self a big favour and start a pension today … oh, and don’t forget to make that dental appointment while you’re at it!

• Tom Barry is a financial consultant with FDC.