What is a Pension?
A pension is a long-term savings plan for your retirement. Unlike a regular savings account, money invested in your pension can earn important tax breaks.
When you retire, and look to access to your fund, the benefits can be drawn down in a tax efficient way. The earlier you start your pension, the cheaper it is for you to provide the income you want in retirement.
Why do you need a Pension?
Once you stop working, you will need an income. Most of us will be entitled to a State Pension of €247 per week (as of January 2018). This will just about cover the basics, but it certainly won’t give you a comfortable lifestyle in your retirement.
Also, you won’t be entitled to a State Pension until you are 66 at the earliest. That will rise to 67 from 2021 and 68 from 2028. Some also question if the State Pension will even be in existence by the time we come to retirement. So, if you want to retire earlier, you will need to have your own pension plan in place with sufficient funds to maintain your standard of living.
When should you start and how much should you save?
If you are wondering when you should start, we say the sooner the better. If you set up your pension early, the money you save has longer to grow, so you don’t need to put as much in.
But it is never too late to get started. You may just need to pay in more of your salary to make up for lost time.
There is no “one-size-fits-all” answer here. It really depends on 3 things:
- How much can you afford to pay: Think about how much you have to pay in bills and basic living expenses, and then look at what you have left? You can always increase or decrease the amount as your circumstances change.
- When do you want to retire: If you start late or want to retire early, it makes sense to put as much as you can afford into your pension. That will help to make sure you have a sufficient retirement fund when you need it.
- How much you think you will need for a comfortable retirement: Ask yourself these questions – What bills will you have to pay after you retire? Will you have any debts to pay off? Have you decided what kind of lifestyle you want to have? Do you have any investments, property or savings that could also give you an income after you retire?
Rules and Benefits:
Like all good things, there are some rules to be aware of. There are limits on how much you can pay every year into your pension fund, but these are very generous. There are also rules about how and when you can take your pension benefits. The basic idea is that a pension is meant to provide an income for you when you retire so you are generally not allowed to dip into it.
The government recognises how important it is for people to plan for their retirement, so they offer generous tax relief for those working and companies who take out pensions for their employees. This makes a pension, without doubt, the most tax efficient way of building up your retirement fund.
Tax Relief on Contributions:
The government lets you invest sizable amounts of your earnings into a pension and claim tax relief at the highest rate you pay. As you get older, the amount you can invest each year increases.
Tax free growth on your investments:
Any growth on your investments is tax free – you don’t have to pay income tax or capital gains tax on it.
A tax-free lump sum when you retire:
For a lot of people, one of the best parts about retiring is being able to get a portion of their pension fund as a tax-free lump sum, so you could finally have the money to buy that car you have always wanted, or go on that dream holiday you have been planning for years.
Investment option with your Pension Funds
Where is your pension Money Invested?
There is a huge misconception in relation to pensions. You have almost as many investment options with pension funds as you do with saving or cash in your bank account. You can invest your pension in any or a mix of all of the following:
- Managed funds– through the Insurance companies. There is a huge amount of choice here. Where your money is invested is directly related to the amount of risk you want to take-from very low to very high…… it’s your choice.
- Bonds– structured bonds and government bonds.
- Shares – you can have your own share dealing account for part or your entire pension. The advantage of buying and selling shares through your pension is you pay no tax on the gains you make. All returns in a pension are tax free.
- Property– you can purchase a property with your pension money. The main advantages are that the rental income on the property is tax free and if you sell the property there is no capital gains tax as all returns in a pension are tax free.
- Start-up companies– if you are interested in a start-up company and would like to invest some of your pension money into it, you can.
Pensions are a tax efficient way of saving for your retirement, you control how much you save (within limits) and what you invest in.
Types of Pensions:
There are various types of pension to choose from. They are as follows;
- Personal Retirement Savings Account (PRSA):
A PRSA is a flexible, portable, cost-efficient and easy way to manage your pension. It is available to anyone, regardless of their employment status. It is a portable pension that you can take with you if you change jobs. It is flexible for both you and your employer.
The main benefit of this option is its Flexibility – it’s portability.
- Personal Pensions:
A personal pension policy is for self-employed people or those who do not have a pension through their employment. It is most suitable for sole trader such as Tradesmen, Beauticians, Hairdresser, Solicitors, and Accountants etc who work for themselves.
- Occupational/Company Pensions:
A Company pension is a pension that is set up for the employees of the company. Both the individual and the Company usually contribute into this pension on behalf of the employee. It is at the discretion of senior management of the company of who will be offered this benefit and how much the company is willing to contribute into each employee’s share. All pension money in usually kept together in one big pension pot and invested wherever is decided by senior management. On retirement or on change of employment, each employee is entitled to his/her share of the pot. It can be transferred out and taken with them if they wish.
There are a wide range of company pension options to suit the needs of all employers, from small start-ups to large corporate organisations.
Providing retirement benefits to employees is an excellent way to reward, retain your staff and to demonstrate how much you value their long-term commitment to your business. Today’s business environment presents both financial and legal challenges for employers looking to provide benefits for their employees. It has never been more important to ensure that you have the right company pension plan in place to provide the pension and protection benefits your employees need.
Main Benefits to an Employer in providing a Company pension to its employees;
- Recruit and retain high quality staff.
- Enhance and maintain performance at work: Providing a pension scheme, into which you as the employer are paying contributions, is a very real indication of how much you value your staff. It will give them a sense that they have been recruited for a career, not just a job – and they are likely to respond to it through a greater degree of commitment to your business.
- Your employees will consider their pension as a sign that you care about their current concerns and their future welfare. It can enhance your reputation as a responsible and considerate employer.
- You will maintain control of the costs to your business by being able to define how much you contribute to the pension scheme for each employee.
- It is a much more tax efficient method of increasing a quality employee’s payment arrangement (as compared to increasing salary).
The 2 main types of Company Pensions
Senior Management needs to decide on what type of pension plan they are going to offer. The difference between the two types is got to do how they will calculate and distribute the pension money to employees at retirement. The 2 types are;
- Defined Contribution (DC) schemes:
This is where the final fund value of all contributions is used to provide a pension and/or a lump sum on retirement to it beneficiaries. The final fund value will depend on contribution levels, fund performance, fees and charges. Both Employer and employee contribute a set amount or set percentage of salary into the pension. The Employer gets corporation tax relief and the employee gets income tax relief on contributions. This is the most preferred
- Defined Benefit (DB) schemes:
This is where the company aims to pay a set pension income and/or a lump sum on retirement based on your salary and years of service. Many old pension schemes use this type. Most public-sector employments use this type of pension scheme e.g. teachers, Nurses etc. Both Employer and employee contribute a percentage of salary in order to receive their benefits on retirement. The Employer gets corporation tax relief and employee gets income tax relief on contributions made.
Drawdown Options from Your Pension
Once you reach retirement age there are certain ways in which you can draw down your pension benefits
- The Approved Retirement Fund (ARF):
An ARF is a special investment fund. It is a retirement fund which you can manage, control and can invest in a wide range of options. You can also make withdrawals, as you need them and because you own your own fund, you can leave it to your dependents when you die.
Before you can invest in an ARF you must have a guaranteed income payable at retirement for life of at least €12,700* a year. If not, you must use the first €63,500* of your remaining fund into an Approved Minimum Retirement Fund (AMRF)-see below.
There is a minimum amount that you must take out of your ARF each year. This is called Imputed distribution. The amount is as follows;
- 4% of the value of your fund if you are over 60.
- 5% of the value of your fund if you are over 70.
- 6% of the value of your fund if your ARF exceeds €2 million.
- Purchase an Annuity:
One option that is available on all pension plans is to buy a retirement annuity. This is what people usually refer to as a pension. It is where your retirement fund is used to buy an agreed income for you for the rest of your life. The level of income is based on the value of your pension fund at retirement and the type of annuity that you choose.
You are exchanging your pension pot for a guaranteed income for the rest of your life, no matter how long you live. You have the option of choosing an Annuity that increases at a set rate each year, guarantees payment for a specific number of years or can provide a percentage of your income to your spouse after you die. Obviously, the higher the income you want on retirement, the more you are going to have to exchange from your pension pot to buy this income.
The amount of income you can get will depend on:
- The level of interest rates at the time you buy your annuity.
- The size of your pension fund.
- Your life expectancy at retirement age.
In Summary the Annuity option is for you if you want a guaranteed income for life when you retire, no matter how long you live for.
- Take a Tax-Free Lump Sum on Retirement:
You can take a portion of your pension fund as a tax-free lump sum upon retirement. The amount available to you tax free can differ depending on your status as an employee, director or self-employed. The remainder of the fund can be used to purchase an annuity or be invested in an ARF or AMRF (See below).
- Approved Minimum Retirement Fund (AMRF):
An AMRF differs from an ARF only to the extent that, until you are 75 years old, or you become in receipt of a guaranteed pension income amount, you may only make one withdrawal per year up to a maximum of 4% of your AMRF value. Any cash withdrawals at this stage will be taxed as income. When you reach age 75, or upon you become in receipt of a guaranteed pension income amount, your AMRF will automatically become an ARF. You will have to pay tax on any money you withdraw from your ARF or AMRF. That includes income tax, the Universal Social Charge (USC), and Pay Related Social Insurance (PRSI) if you are under 66.
- Pension Buy Out Bond:
A pension Buy Out Bond is an investment into which you can transfer your pension money that you have saved in a group/company pension scheme, usually used when changing employer. It is a way of moving your pension funds from your previous employer into your own name and you have complete control over it. You choose the investment you wish to use and the level of risk you wish to take. In the event of your death the value of your Buy Out Bond is paid to your estate.
You can draw benefits from your Buy Out Bond from age 50 onwards. You can take 25% tax free and purchase an annuity, an approved retirement fund (ARF) or approved minimum retirement fund (AMRF) with the balance. Alternatively, you may draw the benefits at your chosen retirement age in line with any other pension funds you have.