The current crop of younger workers may not have access to a State pension comparable to today’s offering. With that in mind, Simon Shirley shares his tips to help you prepare adequately for retirement.
The state welfare system in Ireland and other European countries provides the main or sole source of income for many in retirement. However, the long-term sustainability of these systems is questionable given countries’ enormous unfunded pension liabilities and future demographic challenges. This is known as the ‘pensions timebomb’.
The simple reality is that the proportion of the population in retirement is steadily increasing. Recent projections highlight that, at present, Ireland has five workers (aged 15-64) for every senior citizen (aged 65+). By 2050, we will have only two workers for every one senior citizen. Over time, this trend will likely increase the percentage of State resources being spent on healthcare and pensions for older people, with potentially insufficient tax revenue from the working population to support this.
To ensure an adequately funded retirement, individuals must pay attention to pension planning on a consistent, ongoing basis. Here are some of the key pension issues you need to know.
How much money needs to be saved for retirement?
The answer is usually between 25-35% of lifetime earnings. However, workers often ask how this level of savings can realistically be achieved even if employer contributions are paid into their pension plan. I suggest the following:
- Determine how much of your after-tax earnings you can afford to pay into your pension plan each month. The gross pre-tax contribution amount will be higher due to the tax relief that applies to pension contributions.
Increase the contribution by between 1-2% of gross earnings each year, if possible. Depending on your age, this simple move could double – or even triple – the value of your pension plan at retirement. Also, consider paying bonuses or commissions into your pension plan (subject to annual contribution limits for tax relief).
Where does the money go?
Many pension plans hold hundreds or even thousands of individual investments worldwide to generate a return while reducing the risk of overexposure to any particular investment and/or region.
The market value of these investments can fluctuate significantly in the short- and medium-term, and thus the value of pension plans can also fluctuate significantly. However, pension plans often hold investments for a very long period.
Accordingly, short- and medium-term fluctuations in investment values in pension plans are less relevant for individuals who have ten or more years to retirement. Contributing to a pension plan is more of a marathon than a sprint.
What happens to the money in retirement?
The time we spend in retirement is likely to be at least half the time we spend working. However, many are unclear about what happens to our pensions when we retire. Here are the key things you need to understand:
- You do not have to stop working to withdraw money from your pension plan.
- In some circumstances, you can withdraw money from age 50 onwards. You can withdraw the money by making a lump sum withdrawal – most, if not all, of this lump sum can be tax-free. Then, spread out the balance to provide an ongoing income in retirement. This income is taxable, though many individuals in retirement have an effective tax rate of under 15%.
- If you die before retirement, the value of your pension plan will be used to pay benefits to your dependants/next-of-kin.
- If you die during retirement, benefits can continue to be paid to your dependants/next-of-kin, depending on the options selected at retirement.
- You may be able to withdraw money anytime on the grounds of serious ill-health.
- You do not need to live in Ireland to withdraw money from your Irish pension plan.
For young Chartered Accountants, my general guidance is not to assume that the current level of State pension payments will automatically apply at retirement. The prudent approach is to begin a private pension today.
Simon Shirley FCA is Managing Director of Simon Shirley Advisors and author of A Practical Guide to Pensions and Life Insurance.