Should I pocket both pension lump sums?
Q I WILL be retiring next year. I have two work pensions — one is a Personal Retirement Savings Account (PRSA) which I have been paying into since I became selfemployed about 10 years ago. The other is a defined benefit (DB) pension plan which I was a member of for more than 20 years until I left that job to become self-employed. I will be entitled to retirement lump sums from both pensions. Should I take both retirement lump sums up or can I use one to boost my annual pension instead? Declan, Howth, Co Dublin
LUMP sums are a popular element of pension planning. The first €200,000 lump sum is taxfree, with the next €300,000 taxed at 20pc, making these very attractive and tax-efficient up to that level.
You can take up to 25pc of your PRSA fund as a retirement lump sum. If you don’t take the retirement lump sum and leave that portion in your PRSA, it could be taxable when you withdraw it in the future. For that reason, the tax-free retirement lump sum available from a PRSA is usually taken at the point of retirement.
The lump sum available from your DB pension will be calculated from your 20 years of employment and your earnings with that employer. Unless you have additional voluntary contributions, the lump sum is likely to be provided by foregoing part of your DB pension. Whether to take this option is a major decision at retirement.
Sometimes the factors used to swap DB pension for a retirement lump sum do not look very attractive. For example, they may assume you will live for only 10 or 12 years after you retire. However, it often makes sense to take the retirement lump sum when you factor in that the DB pension being given up will be subject to income tax and USC – the lump sum may be tax-free.
The merits of taking the lump sum depend on your circumstances. If you want to boost your pension, you could take a lower retirement lump sum to maintain your full DB pension, or you could leave more in your PRSA to provide retirement income. The decision depends on the options provided in the two arrangements and you should seek financial advice before deciding.
Brexit pension worries
Q I HAVE a defined contribution pension plan. Much of my pension fund is invested in overseas assets and in particular, assets with a lot of exposure to the British and US economies. I’m worried about the impact that high inflation might have on my pension fund. What type of assets might I consider investing in to manage the challenge of high inflation? I’m also worried about the impact of Brexit on my pension. Should I move my pension fund away from assets with exposure to Britain? Eileen, Baltimore, Co Cork
SOME asset types tend to perform better when inflation is higher and can help protect your fund from being eroded by inflation. Investments in property, equities (or shares) and commodities tend to grow at higher rates when inflation is higher over a sustained period of time. For example, over a long period, a company’s revenue and profits should increase at broadly the same rate as inflation, so the equity price should also rise along with inflation.
It is sensible for a pension fund to hold a portion of these types of assets to give some protection against inflation. However, as these assets tend to be volatile over short periods, the proportions held depend on the investor’s tolerance for risk. A fund with a higher proportion of shares will generally be viewed as higher risk.
A common approach to reduce this risk is to diversify the investments held to spread the risk across many different asset classes and within each asset class. For example, the equity portion of a portfolio could include holdings in Britain and the US but also in Europe, Japan or China — or in specialist equity funds such as low-volatility equities. This avoids particular dependency on the performance of any single economy or sector. It must be said that, as the US is the largest economy in the world, it is difficult to avoid investing significantly in US equities when holding a properly diversified portfolio.
The impact of Brexit on the British economy has yet to fully unfold and some investment advisers are reducing their exposure to certain aspects of the British economy, such as property. However, given that many quoted companies in Britain are multinationals that generate much of their earnings outside Britain and are, therefore, not solely dependent on the British economy, it makes sense to hold some British shares to maintain a diversified exposure to the world economy.
The degree to which you can change the proportion of your fund that is exposed to British shares will depend on the options provided within your pension arrangement, and the choices are often limited. If the choices you want are not available with your existing provider, it may be possible to move your pension to another provider who can offer the investment mix you want. The first step is to speak to the adviser on your current pension scheme.
Never too late to save more
Q I HAVE about five years to go until I retire. I have a defined contribution scheme (DC) with my work, and this is the only pension I have. I’m currently saving 15pc of my salary into my pension — while my boss is contributing 5pc. I’m worried that the pension I get when I retire won’t be enough for me to get by on. Is it too late for me to start saving more into my pension and how much more could I save? Seamus, Castlebar, Co Mayo
IT is never too late to start saving more for your pension. The more you have in your fund, the higher the monthly pension you can receive. Saving more may also help increase the pension lump sum you can take at retirement.
The limit will depend on your age but, if you are aged 60 or above, you could increase your contribution from 15pc to 40pc of your salary — if that is affordable for you.
As you are concerned about having enough income in retirement, it is worth undertaking an exercise to estimate your budget needs after you retire. Your annual benefit statement will give you a projection of your likely pension, so you can see if there is a shortfall relative to your budget.
Your pension provider may have an online tool to help you understand how making additional contributions could help you bridge any shortfall. If they don’t, you can use the Pension Calculator on www.pensionsauthority.ie.
Many employers offer access to one-to-one advice as you near retirement age. If your employer provides this, be sure to avail of it so you can address any concerns about your circumstances.
As you are in a DC scheme, the scheme is likely to offer different investment options. Look at the types of benefits you will take at retirement to determine whether your investment choice is appropriate. Generally, you will have the option to take a tax-efficient lump sum from your pension scheme, with the balance invested in an Approved Retirement Fund or used to purchase an annuity.
Many schemes have a lifestyle option that reduces the investment risk as you near retirement and targets a particular type of benefit. However, this will usually be designed for individuals who take their benefits in a particular format. As a result, it is important to review the suitability of this lifestyle option to ensure the benefit format is in keeping with your intentions.