Ignoring your pension problems won't make them go away, writes DOMINIC COYLE

INVESTING IN A PENSION has become a given for middle Ireland over the past 30 years or so. The notion of stepping off the office treadmill to a retirement in which, the mortgage paid and the kids reared, you could enjoy a comfortable standard of living on income that could be as much as two-thirds of your pre-retirement level became the most alluring of office “perks” – particularly in the public sector.

If you were lucky, your employer picked up the tab and, even if not, there was a very attractive scheme of tax relief in place to provide strong incentive.

But now people are feeling the pinch. Noncontributory pension schemes are a thing of the past and the old defined-benefit model that provided a “guarantee” of a certain proportion of working income in retirement is fast disappearing.

Worse still, some people in the private sector are finding that the “guarantee” is more accurately a “promise to pay, if possible”.

Pension performance over the past decade has been nowhere near enough to provide the necessary growth and now even the tax reliefs are under pressure. And all this at a time of recession, in a country with outsize consumer debt – especially on mortgages – and less security in employment.

Q. IS THERE ANY POINT IN STARTING A PENSION IN THE CURRENT CLIMATE?

A. Stripping aside all the clutter, the basic fact remains – people need a source of income in retirement and few are going to be content with the State pension. At best, it pays €230.30 a week for a single person. That’s just under €12,000 a year. As a reference point, a person working a 40-hour week on the minimum wage would earn just under €18,000 a year.

The only way to provide such an income is to put money aside during your working life and, for all its downsides, a pension remains the most effective way of doing this. Despite the cuts in relief, there is more incentive available for pension savings than any other form of saving at present.

Q. REALISTICALLY, HOW MUCH DO I NEED TO PUT ASIDE FOR RETIREMENT?

A. Unhelpfully, there is no predetermined figure. It depends on the standard of living you desire in retirement and your financial commitments. For instance, many people who would have expected very comfortable retirements are currently feeling the strain from outstanding debt on property portfolios that are deep in negative equity.

The National Pension Policy Initiative in 1998 established, as a rule of thumb, that adequate gross retirement income would be 50 per cent of gross pre-retirement income. This figure would include the State pension.

Assume for a minute that your pre-retirement income, before tax, is €80,000, so you are looking at providing pension income of €40,000. Allowing for the €12,000 coming from the State pension, you still need to find about €28,000 a year. On the basis of current annuity rates – which are tied to the yield on AAA-rated bonds, ie, those of Germany, not Ireland – you can expect to receive somewhere between €3 and €4 for every €100 in your pension fund. That means you need to build up a pension fund of somewhere between €700,000 and over €930,000.

Q. THAT SOUNDS A LOT. HOW MUCH WOULD YOU NEED TO SET ASIDE TO RAISE THAT?

A. Obviously that depends on the performance of your investments but a recent illustration put together by Acorn Life showed that a 35-year-old putting aside €500 every month for the rest of their working life and achieving a return of 6 per cent each year on that – something the industry has certainly not managed in the past decade – could expect to build up a fund of somewhere between €360,000 and €410,000. If that is so, and even assuming the growth rates are attainable, you are still looking at paying about €1,000 a month into a pension from the age of 35. There are not many people managing that.

If anything, the recent turmoil in the industry means that occupational funds – those you join through your work – are adopting a lower risk approach to pension fund investment Inevitably that means that the likely returns will be lower.

Q. YOU TALK ABOUT TAX RELIEF BEING REDUCED. WHAT INCENTIVES ARE STILL AVAILABLE FOR PEOPLE LOOKING TO INVEST IN A PENSION?

A. Pensions are being squeezed on two fronts. On one side, the level of relief you can claim on pension contributions has fallen and on the other, the size of the pension pot you can build up is being reduced.

On the relief side, until recently people could claim relief against PRSI and the health levy as well as income tax at their marginal rate (41 per cent for higher rate income taxpayers). That disappeared last year in the Budget and the Government is currently proposing, under the troika bailout plan, to reduce relief against income tax by seven percentage points – to 34 per cent in the next Budget; 27 per cent in 2013 and the basic 20 per cent income tax rate in 2014. That is under review, but the Minister for Social Protection, Joan Burton, said recently that it would only be changed if other equivalent savings were found in the area of pensions.

Q. AND WHAT ABOUT EXPENSES? WE KEEP HEARING ABOUT IRISH PENSION CHARGES BEING A RIP-OFF. IS THAT SO AND HOW DO I COMPARE ONE OPTION WITH ANOTHER?

A. Pensions are not particularly cheap, and Irish pensions are not cheap even by that standard. Earlier this month, the Government put out a tender for consultants to report on the level of charges imposed by Irish funds. It ïs expected to report by year end, though there tends to be some slippage on these things.

There are several ways of measuring the scale of charges between one fund and another. Most providers will readily tell you the management fee but gloss over other charges that can eat into your savings.

Some tout a “reduction in yield” method which is better but still some way short of comprehensive.

The best measure available to my knowledge is something called the Total Expenses Ratio (TER). It expresses all the charges incurred in a fund – with the exception of transaction costs as a result of trading of the fund’s assets as a percentage of the fund. The lower the TER, the more competitive the fund manager – although you still have to be happy with their investment performance. The reason transaction costs are excluded is because an active fund manager is, by definition, going to be trading more than a passive fund manager and including these figures could distort the picture.

Q. HOW SAFE IS ANY PENSION? HOW DO YOU FIND THAT OUT?

A. Any pension entitlements you have already earned are locked into the system, especially in defined contribution (DC) schemes, where the employer and employee make predetermined contributions and the eventual pension fund is determined by the size of those contributions and the investment performance. You should receive notification annually of the amount of your entitlements

The same is true, in theory, of defined benefit (DB) schemes, where members are promised a certain proportion of their working income in retirement. However, many of these are hopelessly underfunded which puts members’ pension entitlements at risk. Again, you should receive an annual statement from the scheme trustees outlining, among other things, what your pension should be worth at that point and the extent of any underfunding in the scheme.

Q. DO MOST PENSION SCHEMES DEPEND TO SOME OR ANY EXTENT ON THE EMPLOYER REMAINING IN BUSINESS AND IN PROFIT?

A. Occupational schemes are “sponsored” by an employer. In recent years, most of these schemes are defined contribution schemes.

If an employer’s business collapses, the scheme will be wound up and employee entitlements transferred to individual pension plans, Portable Retirement Savings Accounts (PRSAs).

The more traditional defined benefit schemes are more vulnerable. If they are fullyfunded when an employer’s business collapses, the pension entitlements will be transferred. However, that’s rarely the case – the vast majority of DB schemes are currently underfunded – in which case members, particularly those still working, will get less than their entitlements or even nothing.

Q. BUT WHAT ABOUT PENSION SECURITY FOR THOSE ALREADY IN RETIREMENT?

A. If you were in a DC scheme, your entitlements on retirement – after the payment of any lump sum – will have been used either to purchase an annuity, an insurance policy that pays a set income for life, or, more recently into an ARF, an Approved Retirement Fund, where the money can continue to be invested until you need to draw it down.

If you are in a DB scheme, you might have been in receipt of an annuity at the time of retirement, in which case you are fine. Otherwise, as a retired member, you have priority access to the fund in the event of a scheme collapse, although any promised future cost of living increases are no longer guaranteed.

Q. HOW LIKELY IS THE RETIREMENT AGE TO INCREASE FOR WORKERS IN PRIVATE COMPANIES? HOW DOES THIS SQUARE WITH THE STATE PENSION?

A. It’s very likely that the retirement age will increase. The Government has already announced that qualification for the State pension will rise from 65 to 66 in 2014; to 67 in 2021, and to 68 in 2028.

It is unlikely that people in the private sector would still be forced to retire at 65 when they cannot claim the State pension for up to three years thereafter.

Q. NEW RULES ALLOW ME PUT MY FUND INTO AN ARF ON RETIREMENT. IS THAT A SENSIBLE IDEA?

A. Holders of defined contribution pensions, including PRSAs and Additional Voluntary contributions (AVCs) are allowed, since earlier this year, to opt to transfer their fund into an Approved Retirement Fund (ARF) on retirement rather than into an annuity. ARFs certainly have more flexibility. You do not have to lock yourself into an annuity at punitively low rates – such as now – which effectively cut the value of your pension fund.

Instead, an ARF stays invested and you pay tax on it only as you draw down funds. Also, should you die, the balance of the fund forms part of your estate whereas an annuity generally dies with you

On the downside, as your funds are still invested, they are still vulnerable to the sort of shocks that have rocked the markets in recent times. Also, the Government, in an effort to stop wealthier people using ARFs as a tax avoidance measure has decided to “assume” a minimum annual withdrawal from your ARF of 5 per cent and it imposes tax accordingly whether you actually draw down the money or not. If you do draw down the 5 per cent each year, the fund may not last until your death.

Q. WHAT IS THE OUTLOOK FOR PENSIONS?

A. At the moment, rather poor. The cashstrapped Government clearly sees pensions as a source of easy money for the Exchequer. Limits have been imposed on how much of a pension people can put aside and tax incentives to save for retirement are being reduced. Then there is the recently imposed pension levy – marking the first occasion that an Irish

Government has retrospectively taxed savings. On the investment side, returns in recent years have been very poor – managed group pension funds have failed to outperform inflation over the past decade. In most cases they have failed to deliver any positive return, on average, for the past five years.