18th February 2019
The title of this piece may seem overly alarmist, however it is my firm belief that most pensions that people here in Ireland have are really ineffective and the investors would quite possibly be better off doing something else with their funds. Are pensions useful? Absolutely they can be hugely useful (read here for 1 example!) however if they are entered into in a half-baked way they can be pretty useless, and unfortunately I have seen it far too many times.
We all see lots of articles and blogs and media mentions of not enough people having pensions etc etc, however it is also true that getting a pension just for the sake of it is not necessarily the right solution. In this article I hope to share insights which will potentially help you avoid getting into something that is of no value nor use to you, and give you a good chance of getting into something that stands a strong probability of being of real value to you.
What Is The Average Pension or Retirement Income In Ireland?
It really depends on what survey or research you are relying on but I have seen various figures quoted. Some say that the average pension pot for those retiring is €60,000 and other ‘research’ that puts that figure at €90,000. Either way I am not sure how those figures are arrived at, but my experience would suggest that for those that have pensions it may indeed be an average of that sort of level. Some have pension pots of €20,000 and others have pension pots of €1m or more, so it varies greatly! Depending on the size of the pot, the level of volatility you are exposed to and the number of years over which you intend to draw that income, you’ll have a varied retirement income available to you.
For most of us the expectation is that we might retire at 65 or so. When it comes to us retiring at that stage we would still confidently hope to have many happy years ahead of us, no doubt! According to research if you are a male retiring today at 65 years of age you stand a 65% probability of living to 80 years of age, while if you are female today at 65 you have a 75% probability of living to 80 years of age. While if you are a male and female couple retiring today at 65 you apparently stand a 90% chance of at least one of you surviving to 80 years of age. in essence that is a really high likelihood, on average of needing an income in retirement for at least 15 years. If we look at the same bit of research it suggests there’s a 50/50 chance of at least one of that couple living to 90 years of age, which is a 25 year retirement!
If the reason a pension exists, or dare I say it, the reason for investing in a pension is to provide an income for yourself in retirement then surely we can surmise that it really ought to be of a reasonably size if it is to sustain us for 15 to 25 years, and those years where we may not be working at all, and where we may have more time on our hands each week in which to spend it!
How To Invest In Retirement:
Please excuse just a little detour here for 1 minute! I covered this in Blog 53 but it is an opportune time to repeat the war-cry. Let’s assume that you will be drawing an income from your retirement savings for say 20 years. Would you want that income you are drawing each year to increase at least in line with inflation so as to maintain your standard of living? Would you want the assets you are drawing that income from to be growing at at least the same rate, after fees, taxes and inflation? Do you think a deposit account will deliver that outcome for you? Based on the past 100 years of history investing your retirement assets in a well diversified portfolio of equities has delivered these outcomes, while deposit or bonds more-often-than-not have not done so. Yet it is totally typical these days for pensions to automatically default to move a pension-holder’s funds out of equities and into bonds as they get near retirement their retirement age. Playing that out, you then have a pension fund made up of mostly Bonds at 65 years of age, and you then start drawing income out of that every year, say 4 or 5%. That fund, after fees and inflation is potentially delivering you zero (or indeed negative) net returns, and will therefore stand little chance of delivering the income you need every year for 20 years, and even less of a chance of delivering it for 20 years if it is increasing every year! Check out Blog 90 for a little more about all this if of interest.
What Size Of A Pension Should I Have?
Now that we have established that the average pension fund is in the region of €80,000, and that we have a strong probability of needing to draw on the damn thing for nigh on 20 years how much of a pension pot should I have? Well again it is a question that is, in reality, impossible for me to answer. It really does depend on what type of lifestyle you are aiming for once you stop earning an income from whatever it was before you left work! Also, you may have other assets (property, cash, non-pension investments, defined benefit scheme) that will pay you an income and which might remove the need for a pension to do that job for you. Every situation is different, and so I guess I would encourage you to figure out your own number instead of relying on some blog (no matter how award-winning and credible it is!) to tell you what you should do!
What I do find interesting and love to share with you is research done in US by the Employment Benefit Research Institute (EBRI). These really quite interesting research finds that nearly 7 in 10 people surveyed felt that they would need to have a pension pot of at least $500,000 or more. Why they felt that way I have no idea, again maybe they read it in a blog or something! Anyway, the same research goes on to state that the actual retirement pot that those aged 55-64 was $120,000, and those in age bracket 65 to 74 was $126,000. Whatever way you spin it people have much much smaller pension pots than the majority of people think they should have.
Why A Pension May Be A Waste Of Time (& Money!)
OK, I’ve beaten around the bush maybe too much already so let’s get back on track here. I made the claim at the outset that the pensions that a lot of people already have are really pretty useless to them. Please allow me explain. If you have a pension of say €80,000 (and quite possibly feel that you are well set up) let’s see how you could potentially go about drawing an income from it to sustain you in retirement.
Option 1: Take 25% tax free and buy an annuity with the remainder. The numbers will look broadly like a tax free lump sum of €20,000 to do as you wish with or to park in your account for a future need. In terms of the annuity you’ll be handing over the remaining €60,000 to an insurance company and they’ll offer to give you in the region of €2,400 per year for the rest of your days, however many (or few) they may be! This income of course may be taxable and depending on what other income you have, and your circumstances at that time, you may get in the region of €1,800 per year (€150 per month) or €1,200 per year (€100 per month) in net terms. While it certainly is better than nothing it is relatively pointless in terms of making a positive and meaningful difference to your levels of autonomy, choice and lifestyle in our retired years.
Option 2: The other main avenue for getting your money out is by utilising an Approved Retirement Fund (ARF) to take your tax free cash and then hold onto the remainder in order to draw a regular income. In this scenario you might take your max tax free sum, the €20,000. With the remaining €60,000 you plan to invest in an ARF and then draw down a certain percentage each year, minimum of 4% but you can take more if you wish to draw the fund down quicker! However, unless you have a guaranteed income (from state pension and other pensions) of €12,700 per year in retirement then you will be obliged to put €63,500 into what they call an ‘Approved Minimum Retirement Fund’, which may grow tax free until you get to 75, however you cannot access until then, so leaving you kinda stuck for accessing your retirement funds!
On reading about this scenario of an €80,000 pension pot you might think that a pension is a total waste of time, that it’s not worth the effort. To some people in certain situations it may feel like a solution that’ll meet their needs, while others will feel it absolutely won’t. If you had a larger pension pot at retirement the options available are far more attractive, and indeed supportive of a desired lifestyle, however one needs to have the resources and discipline to save and put money into that pension, and we don’t all possess those two things.
We did an article last year of retiring with a pension pot of €1m, and what type of lifestlye this can support, and it can be quite effective in that manner. As we have seen the average pot if far from €1m. However if you do have the resources and discipline to build that type of pension fund you may feel that you might be better-off putting the money into a deposit or savings account instead!? Next week I will be sharing what I hope to be an interesting analysis of investing in a deposit account versus a pension pot, if you are aiming for a pot of €1,000,000, and determine exactly which is the more favourable when you factor in returns, fees, taxation, timing and access…it promises to be fun (if yer into that sort of thing!)
Thanks for reading,
Paddy Delaney QFA | RPA | APA | Qualified Coach
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