Future Proofed: Your Ultimate Guide to Pensions
The good news is that we are now living longer than ever before. The latest statistics suggest that people in Ireland can expect to live to 81.5 years on average. Consider this – longer life means we will need to provide ourselves with an income for a longer period of time post retirement.
Building your personal pension fund is the obvious answer because the sad reality is that the State Pension will only provide an income of about one-third of average annual earnings. Pensions are not the easiest of topics to understand but they should not be neglected because the more you contribute, the more likely you are to achieve financial security in retirement. So, regardless of whether you’re just starting out on your career path or getting close to retirement, you should be planning your retirement now. It’s a topic that has to be considered by everyone at some stage.
The motivation behind an individual’s focus on pension matters varies depending on that individual’s stage of life. For example, a 25-year-old is likely to be more enamoured by the thought of the tax relief available on contributions to a pension fund, while a 55-year-old is likely to be thinking about the ultimate payout and benefits from the fund.
JARGON BUSTER
Hopefully our ‘jargon buster’ will help to explain the meanings of certain pension-related terminology.
Additional Voluntary Contributions (“AVC’s”) - AVC’s are extra contributions you make in addition to the normal pension contributions made by you and/or your employer. Tax relief is available in the normal manner.
Annuity - An annuity is a contract with a life assurance company that will pay you a guaranteed regular pension income for the rest of your life. The amount of the annuity depends on the amount paid in on retirement, annuity rates, age, gender, and state of health.
Approved Retirement Fund (“ARF”) - An ARF is a personal retirement fund that gives more control over how your retirement fund is managed. You can withdraw from it regularly to give yourself an income, on which you pay income tax, Pay Related Social Insurance (“PRSI”) and Universal Social Charge (“USC”).
Defined Benefit (“DB”) Scheme - This is a type of pension plan that pays pension income based on your final salary and number of years of service with your employer.
Defined Contribution (“DC”) Scheme - This is a type of pension plan that builds up a pot to pay you pension income based on contributions by you and/or your employer and investment returns.
Occupational Pension Scheme - A pension scheme set up by an employer to provide retirement benefits for employees.
Personal Retirement Savings Account (“PRSA”) -A PRSA is a type of personal pension policy available from banks, life assurance companies, and through brokers. It is more flexible than a traditional personal pension plan. Used by members of occupational schemes for AVC’s. Also used instead of a Retirement Annuity Contract.
TAX RELIEFS
Tax relief is available on the contributions at your marginal rate of tax, but an individual’s earnings are currently capped at €115,000 for the purpose of granting tax relief. The maximum relief available is based on the following age-related factors (see table):
You may make a once-off pension contribution after the end of the tax year but before the following 31st of October and elect to claim the tax relief in the earlier tax year.
DEFINED BENEFIT SCHEME VERSUS DEFINED CONTRIBUTION SCHEME
Occupational pension schemes are either a defined benefit (“DB”) scheme or a defined contribution (“DC”) scheme. Nowadays, DC schemes are most common. A DB scheme promises a fixed benefit on retirement. The benefit is mostly based on an employee’s years of service and final salary. The fixed benefit to be provided varies across schemes.
A DC scheme invests the contributions made to the scheme, including both employee and employer contributions where relevant, to provide a retirement benefit. The benefit is largely dependent on how the investments perform. The investments are managed by the pension trustees. Individuals generally have no influence over the investment plan.
DRAWDOWN OF PENSION BENEFITS
The precise pension benefits available at retirement depends on the type of scheme and the specific scheme rules.
Defined Contribution Occupational Schemes, RAC’s, PRSA’s and Personal Pensions can facilitate 25% of the fund value up to a max of €200,000 as a tax-free lump sum. The remaining balance can be used to purchase an Annuity Pension or be placed into an ARF to provide a flexible annual drawdown that is subject to income tax and USC. From the age of 60, there are deemed minimum annual withdrawals of 4% which increases to 5% at 70 years old.
A defined benefit scheme income provision is also calculated by length of service and salary, but this also can be reduced to take account of any lump sum received. As a general rule of thumb this tax-free lump sum is up to 1.5 times salary. AVC’s can also be used to purchase an additional pension, within the maximum limits.
Talk to us about taking control of your pension. Call 025-30588 or visit oaktreefinancial.ie