The benefits of starting a pension early

It’s simple maths that those who start their pension savings early end up with better retirement incomes than the late joiners. Don’t mention the avocados, but millennials are much more likely to be concerned with their brunch plans than their pension pots. More seriously, escalating rents and soaring house prices mean that when it comes to saving for retirement, it’s difficult to see past paying for the here and now.

As people get older, the costs of having a family also begin to make pension planning seem like a luxury. This is borne out in the statistics – just 35 per cent of people working in Ireland are currently contributing towards a pension.

What can be done to address this situation? Can the pensions industry work better for the younger generation?

Caitriona MacGuinness, principal, DC and master trust market leader at Mercer, admits talking about pension schemes to those in their 20s and 30s is almost invariably a hard sell. Mercer has a specific communications team looking at what will resonate with different age groups. “You are trying to get them to think about something that is more than 40 years away. We have to focus on clear messages like ‘free money’ – you get these tax incentives from the Government, and if you do not take them, you are essentially giving that money away.”

These communications benefit from a personalised approach, adds MacGuinness.

“Where we can we use technology to send out updates to young people, telling them how much they have saved, and how much of a gap there is. We are using numbers where possible and looking at outcomes of what they will face in retirement tends to resonate a lot an awful lot more.”

Financial institutions have also moved away from the traditional text-heavy, detailed documents of yesteryear, and are instead delivering information in short, snappy formats, typically through digital channels.

“This is what people use in their day-to-day lives so it’s what they expect to get their pensions info on,” says MacGuinness. “We are using things like infographics, making it colourful and engaging, and also making short videos.”

According to David Boylan, pensions technical specialist at Davy, employers have a big role to play in encouraging and supporting employees to join pension schemes.

“It needs to be asked, how much are employers promoting the benefits of a pension? A pension in a company can be quite a significant benefit – they might ask you to contribute 1 per cent, and they will contribute a further 4 per cent, for example. This means that for a very small, nominal amount, you can have quite a decent pension,” he says.

Tax relief

Younger workers need to be schooled on the tax relief afforded by these pension contributions, adds Boylan.

“If you are on the marginal tax rate of 40 per cent, and you put €100 into your pension, it’s only costing you €60. If your company is contributing that other 4 per cent, then that’s €500 going into your pension every month and it’s still only costing you €60.”

Even for those who don’t have the benefit of employer contributions, such as those on contract work or perhaps self-employed, it’s still more than worthwhile establishing a pension plan, adds Boylan.

“The earlier you start, no matter how small your contribution, with investment compounding it’s going to be a lot more impressive in the future.”

Boylan says he always advises clients to draw up a financial plan, but notes this document will evolve as people progress through various life stages.

“When you are in your 20s, you might be living in a city with high rent but if you do have some spare cash to save, a pension makes sense. Ultimately, you want to get to an endpoint where you have enough money built up that you can adequately retire on and it can be quite scary when you show people what that number is,” he says.

“If people don’t start at a younger age, by the time that realisation kicks in, they might find it very difficult to put enough money away because of childcare costs, or a big mortgage. There needs to be a national awareness of needing to provide for yourself in retirement – the State pension won’t cover all your needs.”

Bernard Walsh, head of pensions and investments at Bank of Ireland, agrees that spiralling living costs are making it next to impossible for young people to look ahead to saving for their retirement.

“People have massive pressures in terms of buying their first home and accumulating the deposit needed, especially with house prices at the levels they’re at,” he says.

“This means people are not contributing as much as they should or else they are holding off starting to contribute to their retirement plan. Starting a family also incurs a lot of costs and people can start pushing it out further and further.”

Walsh believes retirement needs to be part of the conversation from a very young age. Bank of Ireland recently established a new unit responsible for financial wellbeing, with a team of coaches visiting secondary schools and third-level institutes. The goal is to educate adolescents and young people about general financial wellbeing, but also to drive the message home about taking the longer-term view when it comes to saving.

“It’s about starting at an appropriate age – you might have missed the boat if you start this education process when someone has already started work. If you start a pension plan the same day you start working, then you are going to have a decent pension pot when it comes to retirement,” says Walsh.

Auto-enrolment, due to be introduced by 2022 for those aged between 23 and 60, will see all private-sector workers who do not have an existing private pension automatically enrolled into a new pension scheme.

This has the power to change the savings habits of the younger generation, believes MacGuinness.

“The idea of auto-enrolment is founded in behavioural finance and the power of the default,” she explains.

“This will build up a 1 per cent contribution of salary from employees each year, over a period of six years, which will be matched by employers plus a contribution by Government. Hopefully, each individual step won’t be painful for people and it is so gradual they won’t be inclined to opt out,” says MacGuinness. International experience shows that the “power of inertia” – aka laziness – means that most people will stay in the scheme.

“If it’s successful and the Government achieve their targets on it, I think it will change the default, where pensions savings will be the norm for 25-year-olds as opposed to having to make the decision to do it.”