One aspect of pension planning which hasn’t changed over the years is the fact that the earlier you start the better.
Take the example of an individual earning €60,000 a year at present who wishes to retire on 50 per cent of their salary inclusive of the state pension of €12,132 per annum. They are targeting a private pension of €17,868 at today’s prices. To achieve this, a 25 year old would have to invest 16 per cent of their salary or €800 a month. This rises to 18.8 per cent (€40 a month) for a 30 year old, 22.6 per cent (€1,130 a month) for a 35 year old, and 27.8 per cent (€1,390 a month) for a 40 year old.
Tax relief softens the blow considerably of course, reducing the 40 year old’s monthly outlay to €890, for example. But 27.8 per cent of gross salary is still pretty hefty. And the cost just goes up the older you get.
“Obviously, there is a need to get the message out to start early,” says Maiyuresh Rajah of State Street Global Advisors. “The impact of a delay on members between the age of 20 and 40 is enormous, for example. The contributions people make during the early years make up the lion’s share of their pension pot.”
He says that people need to understand the real value of a company pension scheme. “It is effectively free money from the company. There is the tax benefit as well. If more people are educated about these things they will hopefully start saving earlier. If they delay they not only have to put more money in they also need more sophisticated investment solutions. The 40 year old just starting out in a pension scheme potentially needs a higher risk strategy.”
The need to start early is emphasised by Colm Power of Davy. “It is acknowledged that very few people in their 20s or 30s put away money for their retirement. But it’s about habit forming at that stage. People should have a pension account even if they don’t put a lot into it, it helps form a good habit. And compound growth is so powerful. If you put away €1,000 now and get 7 per cent return each year it will have doubled in 10 years and quadrupled in 20 years.”
Trevor Booth of Mercer Investment Advisers echoes these points. “The earlier you start a pension the better: not only are you saving for longer, but the effect of compound returns means your money has a far better opportunity to grow,” he says. “The more you save, the better your retirement lifestyle can be. If your employer has a pension scheme, you should make sure you are taking full advantage of their contributions.”
Age starting out is not the only issue affecting pension investment strategies, however. “People are living longer”, says Joe Hanrahan, head of investment and retirement planning with Investec. “The third act is much longer now and you need a big pot of money for that. If you are thinking of retiring at 60 and are going to live until your mid-80s – that’s a very long time. The state pension age is moving out all the time and it could be another eight years before you get state pension.”
The other issue he points to is low interest rates and their impact on the cost of annuities, the traditional fixed income product which people have invested in to purchase a pension. “The cost of annuities is prohibitive now. Consequently, cost of buying a pension is a lot higher than it was 15 or 20 years ago. But we have options now like Approved Retirement Funds (ARFs) but they require people to give up on the idea of fixed income in retirement for the vagaries of the investment markets. You are almost obligated to invest in risk assets when you can least afford to do it. Capital lost at that point can be irreplaceable. You have to invest in ways that get returns but that don’t leave you walking the floor at night worrying about what’s going on in Tokyo.”
Maiyuresh Rajah agrees. “People need to start looking at things differently. We used to look at the three life stages – education, employment and retirement being 20, 40 and 60 years respectively. That is starting to break down as people are living longer. If you live to 100 that model can’t work anymore. People might want to work longer but having a 60-year career is probably wishful thinking. Unless you’re in one of those occupations not affected by time, it’s probably not realistic. We are starting to see people thinking about second careers during retirement. They are educating themselves for it while still in employment.”
Retirement is being pushed out further as well, he notes. “Most people don’t retire any more the way they used to. They don’t just turn off the lights and leave and go home and do nothing. They either don’t want to or can’t afford to. They want to continue working and are structuring their lives differently. The old models are changing quite rapidly and it’s important for investment strategies to cater for that. We are seeing cases of people splitting their retirement in two – from 65 to 85 when they will have a flexible variable income from an ARF and from 85 when they will have a secure income from a deferred annuity or similar product.”
The social aspect of retirement is becoming more important, according to Trevor Booth. “People are retiring healthier than in the past and expecting to live longer in retirement,” he says. “More and more employers are providing retirement planning seminars to help people mentally prepare for their retirement.”
He also notes the option of saving outside of a pension to cater for longer retirements. “For almost all earners, saving for retirement through a pension is the most sensible strategy as there can be tax relief on the contributions paid, tax-free investment growth and a tax-free lump sum payable. Some people prefer to use private property as their retirement income source. However, given the preferential tax treatment of pensions, it is exceptionally difficult to match the potential returns on a pension through any type of investment outside it.”