30th July 2018
As a young boy growing up in the 80’s, a million euros or pounds as it was then, always sounded like an inexorably large amount of money. If you had £1m you were officially a millionaire and were in our eyes elevated to a stratospheric status…….The same can’t be said anymore though!
While it no doubt is still a significant amount of money by anyone’s standards, the sheen of being a millionaire has dampened, thanks to inflation mostly! Nevertheless we are are today going to explore how and if €1m in an Irish Pension is enough to provide a sustainable income. We will specifically explore if it would be enough on which to retire at say 60 years of age.
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Impact Of Inflation On Your €1m:
In order to elaborate on the comments about impact of inflation on your €1m lets just look at that for a moment. It was 25 years ago when I was 13 years of age. When I was 13 years of age €1m seemed like a crazy amount of money. Indeed it was, and still is however if you had €1m 25 years ago (1993) and you put it under the mattress, it would today have approximately 40% less purchasing power, due solely to inflation.
According to data from Central Statistics Office you would need to have €1.61m today to be able to buy what €1m would have bought in July 1993! The price of goods and services here have increased by over 60% in those 25 years. If on the other hand you had invested that €1m in the S&P 500 Index in 1993 it would now be worth approx €12m!
Bottom line is that if you decide to invest your funds under the mattress you will lose every time! If you want to retain and indeed potentially grow your funds above inflation you may need to consider this. If you are a long-time listener you will know our views on that whole topic very well by now however!
€1m Pension Fund At Age 60:
You may be in your 30s, 40s, 50s or indeed a little older but lets fast-forward (or indeed backward!) and assume that you and your partner are now 60 years of age. You have a pension pot of €1m and you are now at a stage that you want to give up working full-time, do more of the things that you love doing, and start drawing an income from your pension funds here in Ireland. You have these funds and your partner has some assets but no significant pension plans (for simplicity’s sake today!). How will you fare-out in retirement, will you have enough to do you?
The first thing to look at is life expectancy. If you are in reasonable health at 60, you stand a 50% chance of living to 90 years of age. In simple terms that suggests that there is a high likelihood that at least one of you will live till you are 90 years of age, therefore you will need an income to support you for at least another 30 years, which is a considerable period of time of course! For anyone to think that a pension-pot of €100,000 for example is going to be loads to provide them with a care-free lifestyle for a 30 year period is naive at best. It unfortunately simply is not enough but this is the very problem many of us are walking ourselves towards by not beginning with the end in mind. The end, we all hope is have a long and dignified life once we transition from full-time employment to retirement. It is never ever too early to start planning for that.
Taking Money Out Of Your Pension Fund:
Anyway, back to the €1m pension fund. For today we are putting aside the whole idea of figuring out what income you will actually WANT to have in retirement, and determining how much of a pension you need to deliver that, we are focused on answering the question of whether this ‘bar’ of €1m provides reasonable income or not. In this illustration we will work on the basis that it is a Defined Contribution Occupation pension or funds you have built up yoursef through a PRSA, Personal Pension or Self Administered Scheme. The various plans will have different rules but the principles remain.
Bridging From 60 to 65
If you retired today at 60 you would not be in receipt of the State Pension for 5 years from now. You will need funds to help you bridge the next 5 years at least, during which time you will be relying entirely on your own steam. One option that may be open to you is to take a tax free lump sum out of your €1m pot. Generally speaking you may be entitled to take 25% of the fund tax free, capped at €200,000 tax free. You have €1m so 25% of that would mean you will pay 20% tax on the €50,000 above €200,000. You therefore decide to take the €200,000 only. If you are planning to enjoy the years between 60 and 65 you could reasonably project that you will burn through a large portion if not all of that €200,000 in the 5 years. This would equate to €40,000 per year, or €3,333 per month if you were to look at it as an income. As mentioned already this is the sole income you have, there is no state pension to bolster your incomes, so the €200,000 gets consumed pretty quickly, but hey that’s what you were saving for right!
Alternatively you could of course decide not to take the lump sum, leave the €1m intact and just draw an income from that. Either way you have a decision to make in regards how best to generate an income with the bulk or all of your funds.
From 65 onwards
The State Pension (Contributory or Non-Contributory) will kick in for you from 65 years of age, if you and your partner are entitled to the full benefit you may receive €243 per week plus €218 for a ‘qualified adult’. The impact of these additional benefits can therefore amount to €461 per week, or €1997 per month paid directly to your bank account, which is not to be sniffed at by any means. It is worth noting here of course that if a couple over 65 are in receipt of €36,000 per year or less they will pay no tax at all.
Let’s assume for illustration purposes that you did take the €200,000 tax free and you have spent the majority of that. You are now in the situation whereby you have €800,000 of pension pot and you want to use it to generate an income for you.
Option A – Annuity Route:
If we go back to a previous Blog this is the equivalent of giving your cake to an annuity provider and they will drip-feed you a predetermined slice of cake each month for the rest of your days. If you handed €800,000 to an insurance company today they would give you approximately the following:
€2,240 per month for the rest of your days irrespective of how long you live. When you die the pension dies with you, no other benefit paid to your partner/estate. Finito!
Or, if you want to buy an annuity that will provide an income for your partner if you die before them then you will get a lower amount of €2,000 per month, but with the added benefit of your partner receiving €1,000 per month if they survive you. When they die the pension dies too and no benefit paid to their estate.
If you are in receipt the state pensions noted above, plus an annuity income of above you would have a combined Gross income of over €4,000 per month. Given this is only marginally above the €36,000 threshold the amount of tax payable on this will be small, meaning you would actually receive the majority of this income into your bank account with which to enjoy your retirement.
The major draw-back for most people with this approach however is that they hand over the money, they do not ever see that €800,000 in it’s original format again, its gone. The thing that people like about it is that there is certainty of income for as long as you are around, even if the % you are getting out each year represents value that is worse than terrible!
Option B – Retain Control Route (Approved Retirement Fund)
This is the equivalent of keeping your cake and taking a slice as and when you need it, as opposed to giving it away to an insurance company to drop-feed to you at a (currently) really low rate. This is taking the approach of investing the €800,000 into a diversified portfolio within a pension structure, Approved Retirement Fund (ARF) for example. You then decide each year to take out a certain amount or %, as an income. The ‘recommended’ % has historically been 4%, based on investing in relatively conservative fund of 60% Equity and 40% Bonds in order to give a 90% probability that the pension pot doesn’t expire before you do! If you decide on this 4% it also happens to be the amount of income on which you will pay income tax USC and PRSI if applicable from age 61 on your ARF funds, irrespective of whether you actually take any income or not from it! When you get to aged 71 this ‘imputed distribution’ automatically kicks up to 5% rate.
The school of thought of investing in more conservative funds made up of mostly Bonds is now being really challenged, and about time I say. Consider that you may be relying on an income from these funds over a period of 30 years. How on earth would it make sense to invest those funds over that period of time in an asset-class that barely keeps up with inflation? Based on empirical data, and historical returns there is only one way that is going to end. Check out Blog 117 where I detail sustainable income strategies, proving this point.
If, for example, you were to take the €800,000, invest it in an ARF in a portfolio of 80% Equities and 20% Bonds which has historically delivered 6% return per year the math suggest that over the long term one could comfortably draw out €32,000 (4%), €40,000 (5%) or indeed even €48,000 (6%) per year without actually eating into your €800,000 capital! There have obviously been many years where a portfolio like this has fallen temporarily in value (2008 such a portfolio fell 40% only to fully recover in following 2 years).
However, if invested wisely and the draw-down income is managed in a sensible manner we can ensure that a fruitful income be generated. Indeed a considerable portion of this income-generating asset can potentially then be passed to your loved-ones when you are finished with it! In Blog 118 I go into detail on some of the strategies that work really effectively at maximising income, and minimising probability of running out of money.
If taking this approach it can be prudent to have 2 or 3 years worth of income ring-fenced in a cash fund or similar within your ARF so that you can draw from these funds when your equity portion is temporarily down in value. As we all know it never makes sense to sell when values are down, instead you wait till values recover and then recommence drawing from equity portion. Over the past 90 years it has been on average just over 2 years from the bottom of the temporary decline in global equity values to a full recovery.
If you were to take this approach of drawing say 4% income from the ARF, when you include full State Pensions, as a couple you would be earning Gross income of over €50,000. Yes PRSI, USC and income tax will be payable on these but at relatively low rates. If you need more income from your ARF you can obviously take it however you are statically more likely to eat into your capital, and depending on the rate your are taking our and the rate of average growth you achieve you will potentially find yourself running our of money before you die which is not ideal in anyone’s book (Revenue charge tax as if you are taking 4% of fund as income, even if you don’t, from age 61, and increases to 5% from 71)
In Conclusion – Retire With €1m Pension Pot?
Getting back to the question at hand, is €1m enough for a couple on which to retire? Well it hugely depends on how much income you want and how you want to get it. It depends on whether you are content with handing your life savings over and purchasing a set (albeit low) income for life, or whether you want to hold onto the responsibility (in conjunction with a competent advisor) of managing the funds and drawing it out in a tax efficient manner which delivers you the lifestyle that you and your partner desire. €1m will not be enough of a pension pot with which to go and buy a luxury yacht, and pay for a crew to boat you around the world. However, for many of us, if invested and managed effectively it would certainly provide a comfortable lifestyle, which is fundamentally what the vast majority of us seek.
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Thanks for reading,
QFA | RPA | APA | Qualified Coach
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