Are pensions only good for tax breaks?

RetirementI think it’s true to say at this stage that most people are aware at some level of the significant tax benefits of pension planning. However, apart from obviously securing your lifestyle in retirement, are the tax benefits the only reason that pensions are good for you, or are there other reasons to start or continue your pension planning?

 

Quick recap of the tax benefits

The tax benefits of pension planning are significant and except for high earners, have been left relatively untouched. The main benefits (within certain limits) are;

  • Full tax relief available at your marginal rate on contributions
  • Your fund grows free of tax (no DIRT, CGT etc.)
  • A portion of your fund can be taken tax free at retirement
  • A structure can be put in place at retirement (Approved Retirement Fund – ARF), which enables tax efficient wealth transfer to your estate on death with any remaining fund.

However there are many other factors that make pension planning very attractive. Here are a few factors that increase the need for pensions, followed by an opportunity that is available to many self-employed individuals and company directors that passes some people by.

 

Life expectancy

Life expectancy has been increasing steadily in Ireland and is now 78 years for males and 82 for females. While this is undoubtedly good news, unfortunately it means that we will all need a bigger nest egg to see us through our golden years. More and more people will now be retired for 25-30 years. What size pension fund would you need to maintain your lifestyle for that period? Many people seriously under-estimate the size of their required fund to maintain a chosen lifestyle over such a long period of time.

 

State pension rates not increasing

Unfortunately long gone are the days when the annual budget heralded a small increase in the state contributory pension in line with inflation. In fact there hasn’t been an increase since 2009, with it currently stubbornly stuck at €230 per week and little prospect of an increase coming any time soon… Indeed in last week’s budget, we saw a further whittling away of benefits enjoyed by pensioners, with more restricted access to medical cards and the removal of the phone allowance. This basically devalues the pension every year, making it even more important for people to carry out their own retirement planning.

 

Waiting longer for the State pension

Employees retiring at 65 in 2013 can get the State Pension immediately. However if you don’t reach 65 until 2014 or later, you’re going to have to wait longer before you get the Pension.

One of the cutbacks in recent years, which received little attention, was the pushing out of the State pension age from 65 to 68, in instalments. The first cut happens in January 2014 when you’ll have to be at least 66 to qualify for the Pension. After that it increases in instalments to 68, depending on when you were born. The bottom line is that if you were born after 1960, the changes mean that you have lost out on 3 years State Pension (say about €36,000 in today’s terms) or 2 years (say about €24,000) if you’re self employed. So if you are still planning on retiring at age 65 or before, you will have to fund for this lack of state benefits for these years yourself. A pension plan is probably the most appropriate and tax efficient way to do so.

And now for that opportunity!

 

Employing your spouse and gaining valuable tax and pension benefits

If you work for yourself but your spouse currently doesn’t work in the business, it may make financial sense for him or her to get involved in the business. There are a number of tax and pension
planning advantages in your spouse working in your business in return for a taxable income:

  • As a married couple with two incomes, up to €65,600 of taxable income is subject to standard rate tax, but the limit for a married couple with one income is just €41,800. This means more of your total income is taxed at a lower rate if you are both working.
  • If you’re in a partnership or your business is a company, your spouse’s employment by your business may be insurable for PRSI purposes, which means he or she may qualify for a State Pension, or for a higher pension, in their own right in respect these additional PRSI contributions.
  • The business may be able to set up an employer pension arrangement for him or her, and any contributions the business pays into it will be tax deductible as a business expense, within certain limits, without causing a Benefit in Kind for your spouse. Some or all of this retirement fund could be taken tax free by your spouse when he or she retires, subject to certain restrictions.

 

The Need for Advice

These are just a few thoughts on the value of pensions, over and above the much heralded tax benefits. Pensions are a very complex area, unnecessarily so in our opinion! As a result, it is our job as an adviser to clarify and find the right solution for clients. Please give us a call to help us find the right pension solution for you.

 

 

7 years on – what have we learned?

five years experienceThink back 7 short years. A huge US investment bank that few people in Ireland knew much about called Lehman Brothers collapsed and started a shockwave in global banking that had huge ramifications in Ireland. Soon after, we saw the government guarantee scheme, followed by the collapse of Anglo Irish Bank and then the biggest recession in Irish history.

The recession has had enormous consequences for people in Ireland. However, some people have definitely been affected much worse than others. So as individuals, what are the lessons to be learned to best protect us against any future economic downturns?

 

Have a long-term investment strategy

The people who suffered most in the economic collapse were those who had no plan and tried to call the market. These people typically sold assets such as shares or property after significant falls in value and then after suffering so much, were very slow to re-enter the market and missed most of the recovery. In fact, stock markets had pretty much fully recovered in 2011, but many people were out of the market for much of the recovery period and their portfolios did not recover.

People with a plan typically stuck to it and avoided making short-term calls. As a result they did not make large scale asset movements and as a result, they experienced both the collapse, but more importantly the recovery in the markets.

 

Diversification is key

In Ireland in particular, this is one lesson that many people have bitterly learned. No matter what your investment objectives are, it is very important that you protect yourself by not being over-exposed to one asset category in particular.

A decade ago in Ireland, many people began to think that property was a one-way bet; that the only way was up! It was deemed disastrous to be “out of the market” as banks lent money with abandon and people over-extended themselves, buying in Ireland, the UK and then in more exotic places, some of which they knew nothing about. And then the global property crash happened. All those people who were invested only in property bore the brunt of the ensuing pain.

 

Debt must be carefully managed

A lot of the problems in Ireland were exacerbated by the easy access to credit, offered by the banks. Many people subsequently borrowed huge amounts of money, with little thought given to their repayment capability, assuming that capital growth would continue apace. The opportunity to make significant gains was there for highly leveraged individuals as the market continued to grow.

But unfortunately as the market collapsed, these individuals suffered greatly as their losses were multiplied in line with their high levels of leverage. Many have suffered to a point of no return financially and unfortunately face the loss of their assets and indeed in some cases bankruptcy. This has been a salutary lesson for all of us, to ensure our debt levels are manageable.

 

Keep emotion out of it

Investing is an art not a science. If investing were a science then there would simply be a formula for success. We all know this is not the case. Our successes (and failures!) are strongly affected by uncontrollable issues, which emotionally affect us and cloud our judgement. These influences are many. Things such as random events, investor sentiment, market momentum and of course, plain, simple luck all have an unpredictable and inconsistent influence on markets. Analysts are always trying to rationalize these issues, define them and ultimately predict their timing and influence. This is of course nigh on impossible.

The people who tend to suffer most are those who exhibit extreme emotions. Being too greedy is a recipe for disaster in a rising market, as these people often don’t take the opportunity to lock in any gains. In a falling market, excessive fear is also a big enemy as people exit the market and are too fearful to re-enter, thus missing a market recovery. The answer is to make investment decisions on logic alone…both yours and that of your adviser!

 

(Some) cash is king

The economic collapse resulted in a lot of pain for many people, with salary reductions and a large increase in unemployment being two of the most unwelcome effects.  For these people, cashflow became an immediate issue as their non-discretionary outgoings (such as mortgage and other loan repayments) typically did not reduce in line with the fall in income. This caused significant issues for people with no cash buffer as they struggled to deal with banks and other creditors, resulting in significant financial pressure, stress and a dramatic fall-off in their lifestyle. Going forwards, many people have prioritised a cash (or other liquid asset) buffer as one of their investment objectives.

 

Don’t go it alone

As people saw their portfolios collapsing and faced uncertainty about their financial futures, it became more and more difficult to make rational decisions. This is where a trusted voice became extremely valuable and for many, that voice was their financial adviser. They were able to stand back, remove the emotion from the situation and provide clear thinking in a difficult situation. Sometimes the advice given was to do nothing, often the right advice! For other people, their adviser was able to help them face up to their situation and plan on how to deal with it.

Having that second opinion, apart from the positive impact it will have on your financial wellbeing will also seriously reduce your stress levels!
I look forward to any comments you might have – are there any other big lessons to be learned?