Pensions adequacy, planning for better life expectancy

By 2070, males born in Ireland will be expected to live 22 years longer than they would have in 1951, while females would be expected to live 23 years longer. 

Earlier this month, the Department of Finance released a report which suggested that the best way to deal with the pensions timebomb was to link the state pension age to life expectancy.

The report was not greeted with enthusiasm. Political pressure after the last election forced a deferral of the planned increase in the pensions age from 66 to 67. With the publication of this report, however, we can expect the debate to heat up again.

‘Population Ageing and the Public Finances in Ireland’ pointed out that we’re all living much longer than we used to. Males born today are expected to live 17 years longer than those born in 1951, while females are expected to live 18 years longer. By 2070, males born in Ireland will be expected to live 22 years longer than they would have in 1951, while females would be expected to live 23 years longer. Alongside that, the birth rate is falling.

Projections suggest the Irish population will reach 6.5 million by 2070. The population aged 65 and over is set to grow significantly faster than the working-age population, however. The report says that Ireland’s old-age dependency ratio is set to nearly double over the next 30 years, increasing from 24% at present to 47% by the middle of this century.

To put it another way, there are currently around four people of working age for every person aged 65 and over. By 2050, the equivalent figure will be half that.

The conclusion? Link the state pension age to life expectancy and keep us all working longer.

For those of us already saving for retirement, these life expectancy projections are good news of course, but they also mean that we’re going to have to fund this additional time on earth.

Providing for retirement is one thing. Providing enough for retirement is quite another. If your pension contributions won’t deliver the lifestyle you want at retirement, there are ways and means of upping your contributions and/or making lump sum investments into your pension pot.

If you already have an occupational pension, the best way to do this is via the Additional Voluntary Contribution, or AVC. AVCs are a way of increasing your employer pension benefits if they may fall short of the maximum benefits you can get at retirement.

Basically, you decide the level of AVC you want to pay. Tax relief is available on contributions, subject to age criteria. The older you get, the greater the relief. The AVC is paid into an investment fund, which is usually invested in a mix of shares, bonds, property and cash. Like all investments of this nature, the value can fall as well as rise.

At retirement, your AVC fund is used to top up your retirement benefits. You can decide how to use the fund, within certain limitations.

You can use your AVC fund to top up your tax-free lump sum, or you can use it to transfer any balance to an Approved Retirement Fund or ARF, which you can draw down in retirement. Alternatively, you can use it to buy an annuity. This is a contract with a life insurance company that will pay a regular pension income for life in return for a capital sum.

Any balance in your ARF on death in retirement is payable to your dependants.

Crunching the numbers

The CCPC offers this example: ‘John works in the private sector. He finds out that he is entitled to take €36,000 as a maximum tax-free lump sum at retirement from his employer’s scheme. He has also built up an AVC fund worth €50,000. John decides to use €36,000 of his AVC fund to take his tax-free lump sum. This leaves him with €14,000 that he could use to buy an annuity and get an extra pension income from his employer’s scheme, invest in an ARF or take a lump sum (that he would pay tax on).’ 

Talk to your HR department, pension administrator or your union about AVCs. Many public service unions have specific AVC schemes for their members.

The other pension boosting tool is the PRSA — the Personal Retirement Savings Account.

If there’s no facility for AVCs in your employer’s pension scheme, you can set up your own independent PRSA into which you can then pay AVCs. In this case, your contributions will not be automatically deducted from your salary before tax. You will have to arrange to pay the AVCs and claim tax relief yourself.

A PRSA is a type of personal pension that is more flexible than the traditional personal pension plan. Anyone up to the age of 75 can take out a PRSA and you don’t have to be earning an income to do so. If you’re employed, your employer is required by law to offer you a standard PRSA if there’s no employer pension scheme in place, or if you’re ineligible to join or access full benefits.

Ireland’s old-age dependency ratio is set to nearly double over the next 30 years, increasing from 24% at present to 47% by the middle of this century.

If you contribute to a PRSA set up by your employer, you get tax relief automatically and don’t have to claim it yourself. Your employer may also contribute to your PRSA but they don’t have to.

Note too that when you take out a PRSA, there’s a 30-day cooling-off period. During this phase, you can change your mind and close the account without penalty.

PRSAs are defined contribution schemes. The value of your pension at retirement is not guaranteed and will depend on the level of contributions you make, the growth of your pension fund, and the charges you pay. More on these in a minute.

Most PRSAs allow you to pay regular monthly contributions or lump sums, and sometimes both. If you’re taking one out with the specific aim of paying in a lump sum or a series of lump sums, make sure that the PRSA allows this.

PRSAs are designed to be flexible. You can make transfers from one PRSA to another without penalty and you can also make transfers from an employer pension scheme to a PRSA.

The bad news is that PRSAs come with a range of charges and fees. You have to pay the pension provider for both setting up and managing your pension plan. As the CCPC points out, these charges can have a significant effect on the value of your pension at retirement. Ongoing yearly charges, for example, are calculated as a percentage of the amount of your fund. So the amount charged will increase as your pension fund grows.

The other point to make here is that pensions can be complex products, so you may wish to get financial advice. The financial advisor will discuss your options and recommend a product based on suitability.