Most workers are responsible for their own retirement savings these days, this means they must make savings and investment decisions about products they will often know little about. After all, since we don’t really teach investments in school here in Ireland, the vast majority of Irish workers are being asked to make complex financial decisions blind.
This is where MoneyWhizz come in. The following is what you need to know about saving for life after you stop working and getting on the path toward a comfortable retirement, no matter your career or the size of your pay.
The best day to start saving is today, even if you can save only a little bit.
The most important advice about saving for retirement is this: Start now. Why? Two reasons:
1. The magic of compound interest. This is one of the most fundamental questions in saving, financial planning and investing, and retirement planning incorporates all three; the sooner you begin, the less you’ll have to worry about it later.
Alert Einstein once called compound interest the “Eight wonder of the World” and for good reason. In this example, we explore the case of two people, both young; one is aged 22 and the other 10 years their senior at age 32. If both put the same amount of money away each year (€5,000), earn the same return on their investments (6 percent annually) and stop saving upon retirement at the same age (67), the one that began saving at age 22 will end up with nearly twice as much money as the person that began at age 32. Or to put a value on the difference, the person that began saving 10 years earlier would have about €500,000 more at retirement. It’s that simple.
2. Saving is a habit. It may make rational, mathematical sense to start saving early, but it isn’t always easy. But the instinct to save grows as you do it, in other words, as you see a savings pot develop and grow, so will your motivation to keep it going. It’s a little goal achieved that lifts the lid on endless possibilities.
50:30:20 your money! For general money management and savings goals, we apply a rather simple 50:30:20 rule; 50% of take-home pay is used to purchase life ‘needs’, 30% used for ‘wants’ and then the final 20% is saved. On the savings side, there are two parts, short-term savings and long-term and retirement planning falls into the long-term category. Of course, much of the 50:30:20 rule will depend on your immediate circumstances. So, if you cannot save 20%, that is OK but try to save something, even if it’s just €25 per pay period! Then, try to save a little bit more each year. Remember, try to get into a routine of saving early and often until it becomes second nature.
Understanding Your Retirement Investment Options
Now that you have decided to take action and begin making contributions to your retirement account, the next decision you’ll have to make is how that money should be invested.
The options for retirement are cumbersome and even confusing for a lot of people: PRSA, AVC, OPS, PPP, BOB, ARF and AMRF. They came into existence over the decades for specific reasons, designed to help people who couldn’t get all the benefits of the other accounts. But the result is a system that leaves many people confused.
The first thing you need to know is that your account options will depend in large part on where and how you work.
IF YOU WORK FOR AN EMPLOYER
If your employer offers any workplace retirement savings plan, it’s probably an Occupational Pension Plan (many smaller employers do not.) Each employer will have their own rules as to when new employees can sign up to join the OPS. All you have to do is fill out a form saying what percentage of your pay you want to save, and your employer will deposit that amount with a company that will hold it for you. Here, automation is your friend. The sooner money is taken out for your future financial needs, the less tempted you’ll be to spend it on today’s wants.
Things to Know About an Occupational Pension Plan
Matching: If you’re lucky, your employer will match some of your retirement savings. It may match everything you save. For some employers may ‘match’ 3% of your salary if you also save 3% of your salary (more employers may put a percentage of your salary in to a retirement savings account, even if you do not). It all depends on the employer and the nature of the employee benefits package they offer. Whatever the offer is, do whatever you can to get all of that free money. It’s like getting an instant raise, one that will pay you even more over time thanks to the compound interest we were talking about before.
AVC’s – these are specific top-up options that allow you to take full advantage of the tax-relief Government and Revenue offer. For example, if your employer’s OPS offers a 3% pension contribution and you match with a further 3% but you are age 28, this means that you can still avail of additional tax-relief of up to 9% of your salary. If you are over the age of 29, this increases a further 5% of salary and a further 5% if you are aged over 39. In fact, the percentage of relief continues to rise but we cover that off below.
Caps: How much you can put aside in any retirement savings account depends on your age and income but here is the high level. For those aged 29 and under, they can save 15% of their gross income. Aged up to 39 is 20%; aged up to 49 is 25%, aged 50 -54 is 30%, aged 55 – 59 is 35% and aged 60+, they can save 40% of salary. Second, across all ages, the maximum salary tax-relief applies to is €115,000 per year. This will not be a factor for a majority of workers but for those that earn in excess of the income limit, there is no further tax relief if they save for example 15% of €150,000, the maximum relief applies to the €115,000 cap.
Taxes: When you save in an approved retirement plan, you don’t pay income taxes on the money you set aside, though you’ll have to pay some taxes when you eventually take out the money. The good news here is there are allowances to take tax-free money from the retirement funds saved. Also, funds invested in a retirement account can grow tax-free and this is a really key part of retirement planning.
IF YOUR EMPLOYER OFFERS NO OPS PLAN OR YOU’RE SELF-EMPLOYED
PRSA or Personal Pension Plans
Even where people work for an employer but that employer does not offer an Occupational Pension Scheme, not to worry. The law still has provision where you can still save for retirement and receive the same tax benefits as those that save through an employer-sponsored OPS. Typically, people will be dealing with a Personal Retirement Savings Account (PRSA) or Personal Pension Plan. The PRSA is used more these days.
Where someone works for an employer, that employer must still support the employee by way of having any PRSA contributions taken out of their gross salary, this is to ensure they receive the necessary tax relief they are owed. However, self employed people can do the same, except they will need to ensure they have the PRSA (or Personal Pension Plan) contributions factored into their tax accounts as they are also entitled to tax-relief that same way as employees are.
WHAT HAPPENS IF YOU CHANGE JOBS?
When you leave an employer, you may choose to move your money out of your old Occupational Pension Plan or your own PRSA (or AVC – we’ll come to that a little later) and combine it with other retirement savings from other previous jobs or add it to the pension savings account at your new employer. You can also leave your money where it is; under the existing arrangement with the employer you are leaving.
But leaving your money behind or rolling it into your new employer’s plan may have disadvantages. Often, it can be a case where employer plans may have only a limited menu of investments, so you should check what is on offer at your new employer and compare your options. Also, while this might require the input of a retirement savings expert, it could also be worth your while to audit the total fees that apply to your retirement account. In some cases, you may be able to access lower costs via your new employer or through a Buyout Bond option. Again, this can be very technical but the savings can add up to a significant amount in your retirement account years later.
How to Invest Your Money
You don’t need to be financially whizz to make smart investment decisions.
Don’t be a star!
There are mountains of books that promote how to invest and get you believing that investing is so, so easy. It’s not! The most common question that arises in MoneyWhizz financial well-being seminars is how to invest when presented with a range of investment options. So on this point, let’s see if we can simplify the decision process a little.
Think humble, boring and simple!
The great investment guru Warren Buffet is often credited with the “…don’t be greedy and don’t be stupid…” investment comment. What he is saying is for those that are investing for retirement or for everyday, the trick is to keep it as simple as possible. Retirement funds are managed and they fall into a series of ‘risk’ categories. High risk means that they are weighted towards shares in companies. These can rise and fall in value a lot. There are Bonds and they rise and fall in value also, but the swings in prices are much less dramatic. Then there are so-called ‘money markets’ and this is equivalent to leaving money on deposit…or cash; value rises and falls are not a concern…but inflation reducing the long-term value can be. So, be a little humble. Try opt for investment options that stand a good chance of beating inflation. If you are starting out in work, you can probably afford to take on a little more risk as time is on your side to recover. Some investment options will offer varying amounts of stocks, bonds and money markets so your overall risk or falls in value in the short-term should be contained. Over time, you should be paying attention to your annual statements and as time progresses, you should take advantage of increasing your risk exposure or lowering it as suits you.
Get Help – Most employer-based retirement options, like Occupational Pension Schemes will generally offer employees on-site advisers that can offer some guidance on a range of investment options. Make sure you take advantage of this when presented. To optimise the value of the interaction with the on-site retirement advisers, do your homework in advance and have YOUR questions in place. If you are young, make sure you have a basic understanding of ‘investment risk’ and the time value of money. Ask the on-site adviser if they can provide a broad calculation of how your regular contributions plus those of your employer and the Government tax relief should grow over time based on minimal rates of investment growth at say 2%, 3% and 4%. The goal here is to let you see the interaction of your money and the tax-free compound growth of your money over time.
No Help Available? If you’re on your own, one option is to pick a medium risk investment option that minimises your exposure as you don’t really want to take on the role of day-trader. That way, you have reduced your exposure to investment risk.
There are also a range of so-called robo-advisers that are accessible online. They operate by way of asking you a questions to gauge your goals and risk tolerance. Then, they’ll custom-craft a portfolio of cheap, indexed investments. It might seem a cutting edge approach and it you are really well-versed in the language of investing, tax-relief and risk, they might prove useful but remember, this is your future financial well-being, you only get one chance to make it right so consider including a qualified financial adviser in your planning it this all seems a little overwhelming. So, while the robo-adviser route is not available when setting up a retirement plan, they can be a source of education for some people in advance of meeting with a retirement planning adviser.
Nothing in life is free, even when it comes to saving for retirement. In Ireland there is a new push by the Central Bank of Ireland to make the whole fees landscape a lot more transparent.
The Inside Story on Retirement Savings Accounts
Retirement accounts are not free, and the fees you pay eat into your returns, which can cost you plenty income in retirement. If you are employed, the company that runs your plan (and whose name appears on the account statements) is charging your employer fees for the service. Plus each individual fund in the plan has its own costs. If you are self-employed, you’ll be charged for your PRSA or whichever plan you opted for when you met with your retirement planning product adviser.
Index funds tend to be the cheapest investments available, in addition to doing quite well over time when compared to other funds run by people trying to outperform everyone else’s market predictions.
Another point to keep in mind in Ireland is that the entire fees landscape is very difficult to decipher. The maximum fees financial advisers can charge on retirement accounts is 5% of the funds on setup and 1% as an annual management charge (AMC). However, this is only part of the fees cost to the investor. Due to a concept called ‘tiering’, additional fees play a significant role.
Pan-European and global fund managers are generally featured in the mix of funds that are included in many retirement savings plans. And for each one that is included, they must also be paid. This is where the costs begin to add up. Here, investment strategies that include ‘active’ and ‘passive’ fund management approaches are applied and each carries a cost of planning and implementation. Sounds complex? It is! But what you really need to understand is this; the total cost of your retirement savings boils down to the total expense ratio or TER. It is the measure of the cost of managing your retirement account as a percentage of the money in your retirement account.
To put this in perspective, an employee that took their money out of their employer-sponsored pension scheme and chose to place it in a buyout bond at first thought their management fee was 1%. However, on investigation, they discovered that in addition to the 1% annual management charge being taken for their adviser, the underlying funds were also applying their own various charges. All in, the total annual charge being applied (their advisers and the underlying funds) was closer to 2.5%. So, on discovering this, they then opted for an adviser that charged a €1,000 consultation fee up front but where the all-in TER was reduced to 1.5%. Over time, the value in savings and retirement fund growth was worth €50,000.
The lesson here is that IT CAN REALLY PAY TO PAY FOR QUALITY FINANCIAL ADVICE.
Routine Financial Tune-ups
For most people in Ireland today with a defined contribution retirement account, they will have online access to view the performance of their investment. It’s a good idea to keep an eye on it but also, not become too obsessed by it as values can rise and fall. That said, try review once per year and if necessary, make tweaks to the investment strategy if necessary; this could include increasing or decreasing your risk exposure.
After setting up automatic savings from your pay, it’s easy to forget about it. But as time passes and hopefully, as you earn more and also, get older, you will have the option of increasing your contributions. As explained earlier, as you pass the ages of 29, 39, 49 and so on, you’ll be entitled to higher rates of tax-relief. If possible, put more into your retirement savings as you will be entitled to get more relief from Revenue for doing so. So, once per year, go over your finances, better still, use the Moneywhizz personal budgeting buddy to guide you and then, use the following steps:
1. Nudge your retirement savings up a little
If you followed our earlier advice, you set up your retirement savings account, you will have money automatically taken out of each pay for your retirement fund. It’s a savings hack and you will barely miss it since it is gone before even taxes are taken out. So each year, try increase the amount you set aside by .5% or half a percent once you turn age 29. This means that by age 39, you will be taking more and more advantage of the tax-relief you are entitled almost without noticing the increase. The incremental half-percent growth is a handy trick to grow your retirement savings each and every year without it being too disruptive to your household budget.
2. Reconsider Your Investments
Are you committing too much to paying off a mortgage early and not near enough for your retirement? This can be as a result of a family bias. “Pay off that mortgage as fast as you can” is often a mantra of an older generation but it is not the best use of your income. Mortgages will take care of themselves and yes, you will pay it off. But your retirement years can last 20 year or much more and you really will need to have money in the bank to pay your way. Plus, in Ireland today, it is absolutely the best way of investing as you receive tax-free investments, tax-free growth and at retirement, a lot of tax-free cash also.
3. Rebalance Your Investments
It’s been a great half decade for stocks. So if you set up accounts five years ago with the intent of having 70 percent of your money in stocks, the growth in those stocks may mean that your investments are now in a stock allocation that’s many percentage points higher. If so, it’s time to sell some stock and buy, say, more bond mutual funds to put things back into balance. This might sound a little counter-intuitive but remember our Mr. Buffet quote from earlier, “don’t be greedy and don’t be stupid”, keep your investments in check, stick to your plan and stay the course. This is a long-haul plan and balance is everything.
Getting Your Money When You Need It
Before the official Irish Retirement dates
Presently, the set retirement date in Ireland is age 66. This is set to increase to 67 and 68 or younger workers. However, if you have a personal retirement fund (by way of a work plan, a PRSA, AVC, buyout bond and so forth), it is possible to get access to your money before you qualify for your State contributory pension. This can start from age 50.
The good news: You can receive up to 25% as a tax-free lump sum in the case of a defined contribution plan. Defined benefit retirement funds offer up to 1.5 times salary as a tax-free lump sum.
But there is bad news too: The sooner you begin to cash in on your retirement fund, the less your fund will be benefiting from investment growth.
Once You’re Retired
Once you’re fully retired, how much can and should you take out each year? For many years, financial professionals figured that if you took out no more than 4 percent of your savings each year starting at age 65 or so, you stood a very good chance of not outliving your money. But so much depends on the nature of your investments, your age, your health, your spending and a host of other things. Given that, following a universal rule of thumb could be dangerous.
This might sound a little morbid, but you really need to ask if you are doing enough today to ensure you minimise the cost of life in retirement, especially health-related issues that can cost a lot of money. This can present a real financial challenge in those yours where you will be highly dependent on a fixed income. So, it might be a good idea to plan for your future health, including reducing blood sugars and blood pressure. Both of those can be easily managed through a good diet and regular exercise.
Also, set about meeting with a qualified financial adviser about your entire financial life as you approach retirement. Make sure to speak to someone who agrees to act as a fiduciary, which means they pledge to work in your best interest. If you’re not seeking a long term relationship, find a financial planner who is willing to work by the hour or on a flat-fee project basis.
Before you pay anyone for financial help, however, do some careful work (with your partner, if relevant).
- What do you value most in life?
- How can spending and giving support those values?
- How much is enough when it comes to housing, travel and leisure?
- How much is too much?
Better yet, start thinking about those questions decades before retirement. The sooner you start, the calmer you’ll probably be about the money you do save and the more resolute you’ll be about putting enough aside to meet all your lifelong goals.
We’ve tackled some of the most common questions about retirement saving.
What About the State Contributory Pension?
A question that often arises at MoneyWhizz financial seminars centres on the viability of the State pension system. For starters, it WILL still be around in the future. However, there are always discussions about the age at which people may qualify for it and also, how much it will be worth to claimants.
First, in today’s money, the State pension will probably not be sufficient to provide the lifestyle most people will hope to have in the future. This is why additional retirement savings are so important. Also, if you worked outside of Ireland for a period of time, it is important you take the necessary steps to get any eligible work credits included with your Irish credits to maximise the contributory pension you are entitled to. This can take up to six months to process to advance planning is a must if you want to ensure you have no income shortfall at retirement date.
IF THERE ARE TWO ADULTS IN THE FAMILY WHO BOTH WORK, SHOULD THEY BOTH BE SAVING FOR RETIREMENT?
The simple answer here is yes! Remember, you both will have financial needs in retirement so plan accordingly. Big expenses will include health costs and you should factor in for future nursing home costs as well. But leaving those aside, day-to-day living will require money and more savings will mean more choices later on (and more tax breaks at present if you do save).
There are no hard or fast rules as to how much you will really need in retirement. It all depends on a complex range of factors. For example, you may benefit from excellent health in retirement and have minimal medical costs. But if your home is extremely energy inefficient, this can cost you a lot in heating and heat loss. To remedy this may cost a lot of money. A rather simple and very rough rule of thumb is as follows:
If you require €30,000 to live today, in 20-years time, factoring in for inflation of 2.5%, you will need about €50,000 to afford the same lifestyle. Just keep that in mind as a broad guide.
Given so many financial variables to consider, some people may be tempted to throw up their hands and put off the decision to start saving for retirement or increase their savings. If this sounds like you, STOP! Start small, a few percent of your pay and as the money in your retirement savings account grows, you’ll see the benefits. Save what you can and don’t be discouraged if you feel you are not doing enough… or others might be doing better. This is YOUR life so take those retirement savings plans as they suit YOU!
Frank Conway is a Qualified Financial Adviser and Founder of MoneyWhizz