Too many of us are confused by pensions. We know that Irish funds have recovered strongly since the financial crisis, but also that more than 60 defined benefit pension schemes around the country remain in trouble. So, what’s the reality? How do pensions compare with other investment options?
The answer, in terms of retirement planning, is that they compare very well and are hugely tax-efficient. But they’ve always had an image problem: at 20, we can find many more exciting ways to splash our cash, while at 60 it’s late to retrieve the benefits lost over the intervening decades.
As to the reality of the Irish pensions landscape, it’s one of those rare occasions on which both accounts are accurate.
The value of Irish pensions has been growing at more than 11 per cent a year since 2008, driven largely by a US equities market fuelled by “quantitative easing”. In most cases, all the losses of the global financial downturn have been retrieved.
“Eleven per cent compounded over five years is a very strong return,” underlines Bernard Walsh, head of Pensions and Investments at Bank of Ireland Life. “And over 10 years - which includes ’08 and ’09 and the tail end of the dot.com collapse – it’s a very healthy 6.3 or 6.4 per cent per annum.
“I think most people you asked about the performance of their pension funds over the past 10 years would believe they’d lost money. But the fact is that, with some exceptions, most reasonably well-diversified funds are well in the black now.”
By contrast, many defined benefit pension schemes – promising a specific monthly payout on retirement as against more common defined contribution schemes – were hit during the crisis and are now underfunded when set against members’ putative benefits.
According to the Pensions Authority, 61 defined benefit schemes failed to meet statutory funding standards as of last month. If they don’t take action, the trustees can be forced either to reduce the benefits paid out by the scheme – or to wind the scheme up altogether.
“Those are very serious steps which would only be taken reluctantly,” says pensions regulator Brendan Kennedy. “But unless a sustainable recovery plan is put in place, an underfunded scheme is unlikely to be able to pay the benefits it promised its members, and younger members could be at particular risk.”
In reality, the key to tax-efficient investments other than pensions is that they should be considered only when pension investments have been maximised.
With that in mind, what’s needed in terms of retirement planning in general is a change of mindset which sees individuals take a more active role in how their pensions are invested, suggests Colm Power, financial planning and pensions consultant at Davy.
“I believe we need to see pensions more as what they are: a long-term, tax-efficient investment vehicle. Once we do that, the question becomes, ‘Where is there value in the investment markets?’ rather than ‘Is there value in a pension in comparison with other types of investment?’”
In terms of individual pensions, one option, he says, are self-directed pension funds, which give investors control over the underlying investments. They can choose from quoted equities across a range of markets, there are platforms offering a range of fund managers, and research tools designed to promote more active engagement.
For those concerned about low annuity rates who are searching for tax-efficient returns, property is one attractive possibility, suggests Power. Relief from capital gains tax for the first seven years of ownership has been extended from the end of 2013 to properties bought up to December 31, 2014.
Another option are EIIS or Employment and Investment Incentive Schemes. They provide income tax relief on company investments up to a maximum of €150,000 a year in every tax year up to 2020. Relief is initially at up to 30 percent – rising to as much as 41 per cent where it can be shown that employment has been boosted or that the money has been used for R&D.
For entrepreneurs who’ve started their own businesses and invested in them over the years but who want to sell up as they get older, business retirement relief can be hugely beneficial, says Owen Redmond, head of financial planning at Goodbody Wealth Management.
“When it comes to retirement planning, people who put all that creative energy into their enterprises over the years will often say, ‘Well, I’ll invest in the business, grow it as much as possible, and then I’ll take retirement relief from it if and when the time comes to slow down’.
“If a company owner sells either to a family member or to a third party before the age of 66, he or she can get up to €750,000 in retirement relief from the business.
“They must have been a full-time director of the company for at least 10 years. But having built up the business, they don’t have to sever their links completely. They can remain as shareholders, for instance – another aspect that tends to make it attractive.”
For those concerned about risk, Bank of Ireland Life recently introduced a new risk-assessment questionnaire that should give a much more nuanced picture of how much exposure we’re willing to take, based on a scale of one to seven.
That assessment, says Bernard Walsh, then links in to a series of “iFunds”, multi-manager solutions using a special “all-star” selection of fund managers and offering a range of assets including equities, property and bonds.
“Whatever we choose, we all need to put some serious thought into what retirement will look like – and I don’t mean sailboats and walks in the park,” says Owen Redmond of Goodbody. “It’s about knowing your costs, and how you’re going to meet them.”
Pensions calculator
We all need a wake-up call now and again and, when it comes to retirement planning, the pensions calculator on the Pensions Authority website – pensionsauthority.ie – is designed to shake you out of your slumber with some hard facts.
The average person retiring today at 65 has life expectancy of 20 to 23 more years, says the authority's head of operations and communications, David Malone.
The good news is that that's quite a long stretch. The more challenging news is that it needs to be funded to buy you the lifestyle you'd like to have – and the pensions calculator makes it easier for you to work out the basic figures.
The authority recently issued a helpful list of 11 Tips to Understanding Retirement Saving, some of them obvious, others less obvious, but all providing good, solid advice.
Engage with your future: This is where the pensions calculator comes in … decide the lifestyle you want in retirement and plan for it.
Understand the type of pension you have: Is it an occupational pension scheme, a personal pension such as a Personal Retirement Savings Account or a Retirement Annuity Contract?
Review your pension at regular intervals: Check the adequacy of your contributions regularly and seek advice if you're concerned.
Keep a pensions file: Pension providers are obliged to keep you up to date and that information is crucial for you to assess the current state of your pension.
Information: Never hesitate to ask for any information you require from your pension's trustees, your financial advisor or your provider.
Ask questions: If you need some aspect of your pension explained in plain language, ask and keep asking until you're satisfied.
Charges: Always be aware of charges against your pension fund.
Investment risk: Make sure you understand the type of strategy involved in your pension and the level of risk involved. You'll find more under "Understanding Your Pension" on pensionsauthority.ie.
Tax relief: It is important you understand the tax relief benefits attached to your pension – and that you receive your full entitlement.
Approaching retirement: On retirement you may have a number of choices of how to draw down your pension. This is something you should research well in advance.
Standardisation of state pension age: On January 1 last, a new pension age of 66 was introduced for everyone. That will increase to 67 in 2021 and 68 in 2028.
