With the October 31st tax deadline looming, this is the last chance to set money aside in a pension to avail of tax relief for 2007, writes Dominic Coyle
IT SEEMS A strange time to be telling people to invest in a pension. The economy is in marked decline and people are fearful about their job prospects. To make matters worse, stock markets - where the bulk of pension savings are invested - are in turmoil, while the Government this week again moved to limit tax relief on contributions people may make to fund their retirement.
All in all, not a very conducive environment in which to suggest that people set aside money that they may be unable to touch for 40 years or more.
But this is precisely the time that people need to make a decision on pensions. The tax deadline of October 31st is looming and, with it, the last chance to set aside a chunk of money in a pension to avail of tax relief for last year. That's right, 2007.
Most people assume that income and spending in the back end of 2008 is a matter purely for this year's tax calculations, but when it comes to pensions, there is this added opportunity to make a lump sum investment and receive what continues to be remarkably attractive tax relief.
It doesn't just apply to the self-employed or wealthy directors - anyone can make a lump sum contribution. If you are a member of an occupational pension scheme in your workplace, you can inject this money into your additional voluntary contribution (AVC) scheme if you have one. For those outside the occupational pension scheme umbrella, you can establish or top up a personal retirement savings account (PRSA).
The dispensation provides a once-off opportunity - especially for people who may not yet have opened a pension plan at all - to put money aside for their retirement and cut their 2007 tax bill significantly. A recent pan-European survey carried out for Hibernian/Aviva, found that 64 per cent of Irish respondents regretted not having started investing in a pension earlier than they did.
You have to do it by October 31st and, importantly, you also have to file your tax return for the 2007 tax year by that date.
If you miss the deadline on either of these points, you will not get the relief and there is no way of turning the clock back. If you file your tax return and pay your tax bill online through the Revenue's expanding Revenue Online Service, the deadline is extended to November 17th.
HARD SELL
Selling the notion of pension saving has never been particularly easy. Figures from the Central Statistics Office confirm that, despite several years of intensive campaigning by the Government through the Pensions Board and by individual life companies, just over half the workforce is setting aside money for their retirement.
This is far short of the long-standing Government target of ensuring that 70 per cent of the workforce has some pension coverage, over and above the State pension.
If you strip out the public sector, where there is practically full coverage, the situation in the private sector is that significantly less than half the workforce has made provision for retirement.
CSO data published last month in the Quarterly National Household Survey indicates that for the first time since 2002, the percentage of the workforce aged 25-34 saving for retirement has dipped below 50 per cent, even allowing for the public service.
There are several reasons for investing in a pension. Probably most significant is the need to maintain your standard of living in retirement. Once you stop working, that's it. When we retire, our chances to increase our income reduce significantly.
While it is true that many of us will hope not to have mortgage bills weighing us down by that stage and that, with luck, any children will have progressed to supporting themselves, it is also true that your income will be lower in retirement.
Even if you have made prudent pension arrangements years in advance, you will have only two-thirds of the income in retirement that you enjoyed during your working life. If you are dependent on the State pension, the best you can hope for - even after the latest Budget - is a weekly income of €230.30 from January 1st next - that amounts to about €12,000 a year, and that's if you have made sufficient PRSI contributions through your working life.
Women, especially those working in the home, may well find themselves on substantially less.
TAX RELIEF
The Government, despite recent cutbacks on tax relief for higher earners, continues to make generous relief available on pension contributions.
For people under the age of 30, the Government will allow full tax relief at your highest tax rate on pension contributions amounting to 15 per cent of gross allowable earnings - for most of us that means your salary. As pension contributions are made from gross salary, you also benefit in not having to pay PRSI on these contributions. This means you can save 47 per cent tax and PRSI on pension contributions - almost doubling the value of the amount you put into a pension.
Between the ages of 30 and 39, tax relief increases to cover 20 per cent of salary, rising to 25 per cent for people between the ages of 40 and 49. When you get to 50, the threshold rises to 30 per cent, increasing to 35 per cent at 55 and 40 per cent over the age of 60.
The escalating scale is designed to recognise the fact that most people tend to delay before starting a pension. In their younger years, they are also less likely to have as much disposable income as they contend with heavy mortgage and childcare costs.
The relief is substantially more generous, for instance, than the Government handout that was available under the hugely popular special savings incentive schemes (SSIAs). The trade-off, of course, is that you are locking up your money until you retire.
Benefit consultants Mercer says the Government needs to do more.
It argues that, if a 25-year-old on a defined contribution scheme (see panel) wants to fund the same benefits that would be available to those on a defined benefit scheme - pension income equal to two-thirds of pre-retirement income, provision of half of that amount for a partner and protection against inflation of up to 3 per cent per annum in retirement - it would cost them 30 per cent of pensionable earnings. That's double the current level of relief available.
Aisling Kennedy, senior consultant in Mercer's retirement business, says even if it makes the maximum permissible contributions over 40 years from the age of 25, she says it will never be able to match the pension available to defined benefit pension holders - largely those in the public sector - and is pushing for an increase.
INVESTMENT RETURN
Several factors influence this. In the first place people are living longer. In his Budget speech this week, Mr Lenihan made the point: "We have an ageing population and at the same time more modest rates of economic growth in the future are anticipated . . . this has implications for our tax system in the long run."
This also has significant cost implications for pensions. The longer people are likely to live in retirement, the less pension income they will receive for every €1,000 they have saved in their pension.
Also, pension investment depends in large part on the performance of stock markets. Although most pension funds invest also in commercial property, government and corporate bonds and cash, the majority of holdings - about 70 per cent - are held in shares.
The market turbulence triggered by the subprime lending-inspired credit crunch is the second such setback for stock markets in the past 10 years. The bursting of the dotcom bubble in 2001/2002 also undermined stock market investment.
The end result is that most pension funds have failed even to match the rate of inflation over the past decade - in fact, only Oppenheim (now Merrion Investment Managers) at 5.2 per cent per annum has outpaced the 3.8 per cent average inflation rate over the period, even then not by much.
LONG-TERM INVESTMENT
Benefits consultants keep reminding us that pensions are a long-term investment - designed for 25 to 40 years - and it is true that if you look a bit further back, things are not so bleak. Figures from Becketts show that, over the last 15 years, managed pension funds have average annual returns of about 7 per cent. Even then, after inflation, the return would be less than many people might expect.
Finally, the pension most people eventually draw down through an annuity is closely related to the yield (interest rate) on government or blue-chip corporate bonds. Leaving aside the recent turbulence, the general trend of bond yields has been down. That means you will get less for each €1,000 of your pension fund, limiting retirement income.
So, on the one hand, stock market volatility is reducing growth of pension savings. On the other, as people live longer and bond yields fall, that pension pot does not go as far.
The recent Government record suggests a significant increase in incentives is unlikely. If anything, the Government has been cutting back on relief available. As the minister for finance, Brian Cowen capped the maximum size of a pension fund and the amount of earnings that could be taken into account when assessing tax relief on pension contributions.
The current minister Brian Lenihan this week reduced the income threshold further - to €150,000 from €275,000.
The Government has been toying with reform of the pension system for much of the past decade. However, it has long-fingered bringing forward recommendations over the tenure of at least three ministers for social and family affairs. At the heart of the dispute is a battle between those arguing for improved incentives to encourage greater investment by individuals in private pensions and the Department of Finance, which is concerned at the cost of any such incentives.
If all this sounds bleak, why should people put money in their pensions before the end of the month? In the first place, most of us would struggle to live on the State pension. While some of us may have a measure of occupation pension provision, it may not go far enough and, in any case, almost half of the workforce does not have such cover.
Secondly, if you miss the deadline, the opportunity to avail of tax relief in respect of 2007 is gone forever.
Finally, the timing might actually be in your favour. Those who invested in their pensions on a monthly basis over the past 18 months have seen the value of that investment decimated. However, having hit generational lows, the general view is that shares must rise in the medium term. Investing now, when the market is hopefully at or close to the lows of the current cycle, could prove prescient.
