Pension Basics – Financial Planning for retirement
A pension plan is a long-term savings policy. At a basic level the concept is simple – you put aside money during the time your are employed or self employed and when you reach retirement age and are no longer working your accumulated savings will provide you with an income.
While the concept is simple it can get a bit complicated when you go to choose a pension plan. Currently you may have the option of taking out an Occupational Pension Scheme, Personal Pension / Retirement Annuity Contract, Personal Retirement Savings Account (PRSA) or a Small Self Administered Pension.This is as a result of layers of pension legislation down through the years following various government initiatives to get people saving for retirement.
To complicate matters further, for those who did choose to start a pension, since 1999 there have been over 20 major changes to the Pension Legislation that could have affected your pension plan.
The good news is that there is a commitment from the current administration to overhaul the pension system and simplify the pension landscape.
Despite all the difficulties, starting a Pension Plan is still one of the best ways to save for your retirement. It’s never too late to start a pension and take control of your financial future.
State Pension
The State Pension is the starting place for most Retirement Planning exercises. The State Pension is funded on a “pay as go basis” which means the working populations’ PRSI contributions go to pay for those in receipt of the state pension. With an ageing population and people living longer the cost of providing the pension will increase dramatically over the next 30 years. We should expect changes to how and when we will qualify for the State Pension. It’s not advisable to depend on the State Pension as your sole source of income in retirement
The maximum Contributory State Pension for an individual is currently €233.30 per week (2016) or €12,132 per annum. It is paid from age 66 but this is set to rise to 67 in 2021 and 68 in 2028.
The contributory state pension is not means tested and you can have other income and still claim the state pension.
The rate of pension you receive will depend on the amount of PRSI payments you have made during the course of your working life. If you have lived abroad, Ireland has a number of bilateral agreements that will allow you combine social insurance contributions that you have made in other countries. There are also allowances made for individuals who stop working for a period to take care of children under age 12 or look after sick or disabled children/adults over age 12. Check out www.Citizensinformation.ie for more information
http://www.citizensinformation.ie/en/social_welfare/social_welfare_payments/older_and_retired_people/state_pension_contributory.html#l62fd2
You can request a copy of your social welfare contributions record from welfare.ie
https://www.welfare.ie/en/Pages/secure/RequestSIContributionRecord.aspx
How much of a Pension Fund will I need to retire?
That depends on how much income you will need in retirement. The chances are your mortgage will be paid off at that stage and likewise if you have children the chances are that they will no longer be dependant on you financially.
First of all you be to calculate your essential expenditure like housing, food, car, healthcare etc. Then add on luxury expenses like holidays, golf club memberships and other expenses associated with hobbies.
Once you have done that you need to work out the capital amount needed to provide that benefit. As a guideline we would suggest a multiple of between 20 to 30 times. If your total expenses come in at €45,000 per annum you will need a pension fund of between €900,000 & €1.35 million
This may seem like a lot amount of money but you need to consider that life expectancy in Ireland is currently 80 years of age. If you retire at age 60 that fund could be providing you with an income for over 20 years. You also need to factor in the effect that inflation has on the buying power of your pension over time.
The earlier you start planning for your retirement the better but it’s never too late to put a plan in place. If you find yourself in the position of not being able to pay for the retirement you want, a good Financial Planning process can help you find out what you can afford to spend in retirement. It can also show you the effect of delaying leaving full time employment or retire from full time employment and work on a part time basis for a number of years. If that’s not possible, another option to consider to make up the shortfall could be to downsize your house. The list goes on. The message is that it’s important to review your plans on a regular basis as you approach retirement.
Why choose a Pension Plan
A Pension Plan is a long-term savings account for retirement. It’s one of the best ways to save for retirement . Contributions into a pension can be made by your employer, by you personally or a combination of both.
Income Tax Relief
A pension is different from a regular savings account in that you receive tax relief on the contributions. If you pay a marginal rate of tax of 40% your personal contributions will qualify for tax relief at that level. That means for every €100 you pay into your pension the net cost will be €60. If you pay tax at the standard rate of 20% then the net cost of a €100 contribution will be €80.
No Tax Liability – Benefit in Kind (BIK) on employer contributions
Employees who receive a contribution from their employer into an occupational pension scheme are not liable to pay Income Tax, USC or PRSI on the benefit received.
Tax Free Investment Growth
Pensions also differ from regular savings accounts in that they grow tax free. They are not subject to Capital Gains Tax on investment growth or Deposit Interest Retention Tax (DIRT) that would be applicable on interest earned from a deposit account.
Tax Free Cash at Retirement
25% of the value of your pension can be taken as a retirement lump sum to a maximum of €500,000 (25% of €2million). The first €200,000 is completely exempt from Income Tax and the balance, up to €300,000, will be taxed at 20%
Standard Fund Threshold
The Standard Fund Threshold (SFT) is the maximum pension fund that an individual is allowed at retirement. This is a lifetime allowance and includes all pensions received since 7th December 2005. The current standard Fund Threshold is €2 million.
If when taking retirement benefits your accumulated pension fund is in excess of €2 million the surplus will be taxed at the higher rate of income tax (currently 40%). The tax is taken before any benefits are paid to the individual.
Personal Fund Threshold
The Standard Fund Threshold was introduced in December 2005. At that stage it was €5 million, it was then reduced to €2.3 million in December 2010 and to the current level of €2 million from 1st January 2014.
Anyone who had a pension fund in excess of the Standard Fund Threshold at the date of the changes could apply to the Revenue Commissioners for a Personal Fund Threshold (PFT) based on the value of their pension benefits at that date.
Investing your Pension Fund
This is the part of Retirement Planning that causes people the most trouble. There are thousands of investment funds available in the Irish Market and through self directed pensions and Small Self Administered Pensions you can invest directly in countless individual companies, ETFs or properties. When you take a closer look at all of these investments the four most popular asset classes are Equities or Shares in companies, Property, Fixed Income Bonds and Cash.
An investor should understand where and how their money is invested. Investing is about looking for returns in the long term and shouldn’t be confused with speculating, where a speculator looks for returns on short term market movements. The stock markets create wealth over the long term as both companies and economies grow.
The return on your Investment comes from investment income and also the growth in the value of your Investment. Examples of Investment income would be dividends on shares and rental income from property. Investment growth is achieved by the underlying assets increasing in value . While investments can also fall in value this is less likely for the long term investor. It’s important for anyone who invests money to be comfortable with risk.
There are various tools that will calculate your attitude to risk and this in turn will help you pick investments that you will be comfortable with. In theory the more risk that you take on will deliver a higher potential return on your investments. Once you establish your risk profile you need to align it with your long term financial goals. If you have a high tolerance for risk this doesn’t necessarily mean that you need to invest in high risk investments to reach your goals. Don’t take on extra risk if you’re not comfortable with it or if you don’t need to.
Personal Pensions / Retirement Annuity Contracts (RACs)
Personal Pensions have been available in Ireland since 1968. They are also known as Retirement Annuity Contracts (RACs) and were aimed at providing pensions for the Self Employed Sole Trader along with employees of a company without a company pension plan in place.
Who can do a personal pension plan?
If you are self employed and taxed under Schedule D Case 1 & 11 or if you are an employee in non pensionable employment taxed under Schedule E.
How much can I pay in every year that qualifies for tax relief ?
You will get income tax relief up to the age related limits below. There is however an earnings cap of €115,000.
Age % of net relevant earnings
Under 30 15%
30-39 20%
40-49 25%
50-54 30%
55-59 35%
60 and over 40%
What happens if I die before retirement:
On death the full proceeds of the Personal Pension is paid gross into your estate. Any beneficiaries of your estate will be liable for inheritance tax. There is no inheritance tax between legal spouses or between registered civil partners.
Personal Retirement Savings Accounts (PRSAs)
PRSAs were first introduced in 2003. They are a flexible pension contract and allow you to carry your pension from one employer to another. You can increase,decrease or stop your contributions at any time without any penalty.
Who can start a PRSA ?
If you are resident in the Republic of Ireland with a PPS Number you can take out a PRSA. You don’t need to be earning money to take out a PRSA but you will only get income tax relief if you are paying Income Tax.
Whether you are self employed, an employee of a homemaker you can take out a PRSA. If you are an employee and a member of a company pension scheme you can use a PRSA to pay additional Voluntary Contributions (AVCs)
Contributions can be made to the policy by you and/or your employer.
How much can I pay in every year that qualifies for tax relief ?
As with Personal Pension Plans you will get income tax relief up to the age related limits below and the same earnings cap of €115,000.
Age % of Net Relevant Earnings
Under 30 15%
30-39 20%
40-49 25%
50-54 30%
55-59 35%
60 and over 40%
What happens if I die before retirement:
On death the full proceeds of the PRSA is paid gross into your estate. Any beneficiaries of your estate will be liable for inheritance tax. There is no inheritance tax between legal spouses or between registered civil partners.
Occupational Pension Schemes
Occupation Pensions Schemes include Company Pension Plans along with Executive or Directors Pension Plans. In order to take out a plan you need to be in receipt of Schedule E (PAYE ) remuneration. Also your employer must be willing to set up and contribute to the pension plan.
Defined Benefit Schemes (DB Schemes) aim to provide a set level of pension and/or lump sum at retirement. The level of benefits depends on the employees service in the scheme and salary at retirement.
Private Sector Defined Benefit schemes typically aim to provide employees with a pension of 1/60th of salary for every year of service to a maximum of 40/60th. They usually have the option to take some tax free cash in return for a reduced pension. This type of arrangement may also be integrated with the state pension.
Defined Benefit pensions makes it easy for employees to plan for retirement but have proven an expensive option for employers. As a result the number of Defined Benefits schemes is on the decline.
Defined Contribution Schemes (DC Schemes) are where the employer or both the employer and the employee pay in a regular contribution into a pension plan. The benefit that the employee gets in retirement will depend on the contribution levels, fund performance, plan charges and annuity rates at retirement age.
What are the maximum yearly contributions that can be paid into an Occupational Pension Scheme ?
The maximum yearly contributions allowable into an occupation pension scheme is a lot higher than the maximum contribution for tax relief purposes into a Personal Pension or a PRSA.
Typically, an occupational pension scheme is made up of Employer & Employee Contributions. The Employee contribution has the same limits as a Personal Pension Plan or a PRSA but the Employer contribution is outside of this and gives greater scope for funding.
Maximum Employee Contributions
Age % of Net Relevant Earnings
Under 30 15%
30-39 20%
40-49 25%
50-54 30%
55-59 35%
60 and over 40%
The earnings cap of €115,000 and the standard fund threshold of €2million applies
Below are some examples of the maximum contribution rates as a percentage of salary that can be paid into an Occupational Pension Plan. They assume the employee is married and will have at least 10 years service at normal retirement age . Existing pension benefits are not included in the calculations.
Additional Voluntary Contributions (AVCs)
Additional Voluntary Contributions (AVCs) are additional contributions you can make to your occupational pension scheme to increase your pension in retirement. They can be made along with an employee contribution as long as the combined amount doesn’t exceed the employee limits. Traditionally AVCs were arranged under trust but they can now be set up using a PRSA.
Small Self – Administered Pension Schemes (SSAPS)
A Small Self-Administered Pension Scheme (SSAPS) is an employer occupational pension scheme with less than 12 members. The scheme is self administered which means you make all the investment decisions . A lot of SSAPs are set up for members to purchase property but can be used for direct investment in stocks and shares. The are some restrictions to the type of investments that can be included in a SSAP. All scheme investments must be on an “arm’s length” basis.(see revenue.ie )
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