When we consider pensions, we often do so from a perspective of percentages, along the lines of "if you save X per cent of your salary you can retire on Y per cent of your former income".
But while helpful, sometimes it can lack a bit of everyday applicability.
More resonant perhaps, is to consider just how big a pension retirement fund your current savings trajectory is targeting in euro terms – and just how much of an income this is likely to pay out in retirement.
Nothing can focus the mind quite like learning that, despite all your years of saving, you’re only going to end up with a derisory €321 a month in private pension.
If you’re in a defined benefit pension, where your retirement benefits are based on a percentage of your final salary, this won’t be of concern. For others however, it is a real issue.
As Joe Creegan, head of corporate life and pensions at Zurich Life notes, "the big shift over the last 20 years has been the shift of the risk [in funding a pension] from the employer to the individual".
And many individuals may find out too late that they just weren’t equipped to understand that and act accordingly.
How to estimate your total pension pot
To work out how much your pension fund is likely to be worth, you can simply log in to your pension portal where your provider will give a projection of how much your fund is likely to be worth in retirement.
Initially, this may look decent enough.
“We have people maturing with €100,000 or €200,000 in their pension fund thinking it’s a lot of money; but it has to do them for the rest of their lives: it could be 30 years,” warns Creegan.
It’s likely that, alongside this number, your fund provider will also give projections of your annual income in retirement, and how this matches up to yearly income you hope for in retirement, which may be based on 33 per cent of your salary.
But if you disregard the state pension (which may be included in this figure), you can be left with a figure that’s considerably less than you would have expected.
Remember also, when considering retirement fund projections, it’s important to bear in mind that the value of your fund may in fact fall further or increase faster, than the projections suggest.
For Andrew Fahy, head of financial planning with Quilter Cheviot Europe, examining your "statement of reasonable projection" can serve as a warning shot for a lack of adequacy when it comes to retirement provision, and allows you to take remedial action.
“It can serve as a catalyst to getting a coherent plan in place,” he says, adding that good outcomes in retirement happen because people plan in advance.
Pension pot shock
As our table shows, once you have the figure for your forecast fund size on retirement you might get a shock as to just how much this income converts to. Consider a pension pot of €100,000. It’s a significant amount of money, and may represent the greatest asset many people will have apart from their home. However, it won’t pay out much of an income in retirement.
With an annuity rate of about 4.12 per cent for example, you could convert this into a guaranteed income for life of €4,126 a year, or €343 a month.
Or how about €500,000? This translates into annual income of just €20,034, with an annuity while even a €1 million pension pot will give a guaranteed income of just €40,068 in retirement, and a €2 million fund income of €80,135.
Annuities
The reason the return is so poor is due to annuity rates. With interest rates still at historic lows, annuities continue to offer poor value. This is because the annuity rate offered determines the level of income you receive, and with interest rates so low, this also means a lower income.
Current annuity rate are routinely less than 4 per cent – and even lower if you want your income to increase in retirement to account for inflation or provide an income for your spouse if you die.
“The general perception is that they [annuities] represent poor value,” says Fahy, adding that a further issue is that once the individual passes away, the money is gone.
“The mortality risk piece tends to turn people off as well,” he says, noting that “essentially, it’s a bet with an insurance company”.
On the other hand, the great advantage of an annuity is that, though the income offered by an annuity may appear meagre, it does offer a guaranteed income for the rest of your life. And that may be boosted in a so-called “enhanced annuity”, depending on your medical history. In simple terms, the worse your health or a history of smoking, the higher the annual payout as the insurance company is betting you won’t live as long.
ARFs
Another option that might generate a better income in retirement is an ARF, or Approved Retirement Fund. Unsurprisingly popular given the poor rate of income on offer with annuities, ARFs also pass tax free to a spouse upon death.
“Increasingly people are viewing ARFs as a family balance sheet item,” says Fahy.
In an ARF arrangement, you are obliged by law to draw down at least 4 per cent of your pension fund each year – or 5 per cent from the age of 71. If your ARF pot is more than €2 million, the minimum drawdown is 6 per cent.
Of course, you can draw down more if you need it.
The big difference between this and an annuity, is that your fund has the potential for greater growth as it remains invested – and thus a greater income.
But achieving a better return won’t always be straightforward. If you target the same return as minimum drawdown – i.e. 4 per cent – as Creegan notes, you would need to take on a reasonably high level of risk to get that. Many people entering retirement may be loath to do this and, in general, financial advisers will advise people to reduce their risk as they age if only because they have less capacity to recover from sharp losses in more volatile, riskier investments.
“You wouldn’t get it in bonds, so you’d have to expose yourself to riskier equity markets,” he says.
But if your fund doesn’t grow at a certain rate, then you run the risk of the ARF bombing out too early.
ARF + annuity
It is also possible to split your assets and opt for the guaranteed income of an annuity as well as maintaining the degree of control offered by an ARF by investing in them both.
However, as Fahy notes, this is not a very popular option. Most people take the view that the State pension will provide that annuity style base guaranteed income, and so opt for an ARF.
And there may always be time for an annuity at a later stage. “One option to consider as you get older is that you can subsequently buy an annuity,” says Creegan.
While you might be happy to take an active role in managing your ARF, along with your financial adviser, at 66, in 10 years time you might prefer the comfort of a fixed income, and thus look to switch.
And the income offered by an annuity may look more attractive in years to come, in part because it is base don the age at which you enter the annuity. The older you are, the higher the income from the same-sized pot as the insurer again presumes they will have to pay the money out over fewer years.
For example, a pension fund of €100,000 will generate a guaranteed annual income of €6,035 at the age of 76, thanks to an annuity rate of 6.095 per cent. This is about 57 per cent more than the €4,126 a year you would have received at the age of 66.
State pension
Don’t forget about the State pension. The good news is that if you qualify for a full pension, it will improve your retirement outlook. The pension is currently paid out at a maximum rate of €253.30 a week, or €13,171.60 a year.
For many people with private pensions, the State pension is likely to generate a greater income than their own retirement savings.
As our table shows, this can significantly boost your retirement income. Someone with a €100,000 private pension fund and access to a full State pension will see their €4,126 annual annuity income become annual income of €17,298. For those with the million euro fund, their income will rise by almost a third to €53,240.
Tax free lump-sum
The other point you’ll need to consider is how much you will take out of your pension fund upon retirement. Under current rules, if you have a private or occupational pension by way of a retirement annuity contract (RAC), a personal retirement savings account (PRSA), or a defined contribution (DC) fund, and you’re transferring to an ARF, you are allowed to withdraw 25 per cent of your pension fund up to a maximum of €200,000 tax free.
Lump sums between €200,001 and €500,000 are taxed at 20 per cent, with any balance over this amount taxed at your marginal rate and also subject to the Universal Social Charge.
If you’re in a DC scheme and opt to buy an annuity, you can withdraw 1.5 times your final salary as a lump sum.
Either will give you a significant cash boost though it will also deplete what you have left to buy an annuity with or use for drawdown in an ARF.
For Fahy however, withdrawing the full amount makes sense. “Most people take the opportunity to take money out of a fund on a tax-free basis,” he says. However, they can delay drawing the funds out by setting up several different PRSAs to host their pension savings, as these can then be retired at different times.
