The number one stress for anybody approaching retirement is the unknown of whether or not their pension fund will last them in retirement. Increased life expectancy is putting extreme pressure on pension funding as this income needs to last for approximately 30 years.
Defined Benefit pensions (guaranteed pension income for the rest of your life) are becoming increasingly rare, so it is imperative individuals take control of their retirement planning to ensure they have the correct provisions in place.
How Long will my Retirement be?
For people in their 40s & 50s, the main focus is put on the date at which to retire. Due consideration needs to be given, however, to ensure they do not retire too early and that they have enough funds and other income streams to last until their eventual mortality.
Life expectancy needs to be a core focus of this thought process. If you were to retire at 65, which is the average normal retirement age, and live until 80, which is approximately the current average life expectancy, your money needs to last 15 years.
People living healthier lives combined with continuing improvements in medicine means this life expectancy is expected to increase.
The stress of modern jobs is making a lot of people want to retire a lot younger too. So, for somebody who leaves work at 60 and lives until 90, which would be a very common scenario, they will need a much greater pension pot. If not planned correctly, many people can be left struggling financially later in life.
Why do I need a pension plan?
When you stop working, your income will cease. Your bills and expenses, however, will continue.
The state pension which is currently just short of €13,000 at its full rate, however, there is no guarantee that this will be in existence when you reach retirement age. The age that this is payable from has been increased on a number of occasions over recent years, which would indicate the state has a massive funding gap and may struggle to keep the pension at its current rates in the future. An ageing population is only going to put further strain on future funding so it wouldn’t be a surprise to anybody if the guaranteed pension was abolished or was reduced substantially in the years ahead.
This means that funding for a private pension is imperative to ensure that you have some sort of income in later life. Even if the state pension was still in existence, this income is a lot lower than what most individuals are used to receiving on an annual basis.
Individuals should be looking to fund pensions for approximately 2/3rds their salary less state pension.
How is my pension fund paid in retirement?
You can receive a tax-free lump sum and then the balance will be used to provide you with a pension.
An individual can arrange to either buy an annuity or invest in an approved retirement fund and or Approved minimum retirement fund.
What is an annuity?
This is a guaranteed income for life. There are various types of annuities on offer. For example, some payments will increase in line with inflation and others will provide your surviving spouse with an income when you die. Annuity rates are extremely low at present which makes this a very expensive option.
What is an Approved Retirement Fund (ARF)?
An ARF is an investment fund which has the potential to earn investment returns, but nothing is guaranteed. With this option, instead of receiving a regular pension, you select the amount you withdraw from the fund as required.
Do pensions run out?
This will depend on what type of pension you have. There are two main types of pension plans that you as an individual can pay into pre-retirement, which will dictate the type of pension you may get in retirement.
Defined Contribution Scheme (DC)
In a defined contribution scheme, the employer and employee both contribute to the pension scheme. The levels of contributions will vary from company to company and role to role. The employee can then decide on retirement to either buy an annuity (income for life) or else invest in an Approved Minimum Retirement Fund (AMRF) and or an Approved Retirement Fund (ARF) where you are in control of how your post-retirement funds are invested and where, and how and when you access it.
This gives an individual the opportunity to grow their funds to a greater extent, however, this should always correlate to your risk profile, as there are no guarantees with investment returns and these should match with your personal circumstances.
It should be noted that there could be a risk of ‘bomb out’ where your pension pot is depleted before the end of your lifetime due to too much income being withdrawn or you live longer than expected.
Defined Benefit Scheme (DB)
In a defined benefit scheme, the employer guarantees an income at a certain rate for the remainder of the former employees’ life.
Like most things in life, nothing is ever guaranteed and many DB pension funds run into difficulty due to pensioners living longer than expected and/or poor fund performance of the underlying assets, which in turn reduces the expected funding pool. It is very important to look ‘under the bonnet’ of your pension scheme to ensure that it is financially robust and fully funded. A financial advisor should be able to review your holdings and advise accordingly.
As you can imagine, these type of pension schemes are very expensive to run and are very rare in today’s private sector.
What happens to your pension when you die?
If you are a member of an occupational pension scheme and you die while you are still in employment, a transfer value will be determined and paid out to your estate. The Revenue imposes a rule that only allows a lump sum of 4 times salary to be paid out. A spouse’s pension can be purchased in cases where the value exceeds this limit.
DB pensions are different and each scheme may have different rules. Many of these schemes will provide the surviving spouse with half the deceased’s payment and there could even be provision for a payment to be made to children up until a certain age.
All other your other types of pensions are generally paid as a lump sum to your estate.
What happens to your pensions in retirement will be largely dependent on what route you decide to go down in retirement (i.e. the AMRF/ARF or Annuity Route).
An ARF will pass directly to your spouse and become an ARF in their name with no Capital Acquisition Tax applicable. An ARF may also be passed onto your children. Children over the age of 21 will be liable to income tax but not CAT (inheritance tax). This transfer will also not eat into their CAT tax threshold, which is currently at €310,000.
If an individual has opted to purchase an annuity in their retirement, the income will generally die with you. It is possible to buy a joint annuity, however, these are extremely expensive and will reduce your own initial income in your retirement.In older DB schemes, employees had no option but to take an annuity, however, more recent changes in legislation have given rise to greater options at retirement, meaning individuals can opt for the ARF route.
How do I make a retirement plan?
Planning for retirement can be immensely difficult as there are so many variables which need to be accounted for. There are also major decisions which need to be made regarding what pension structure should be put in place and there is no one size fits all approach as each person will have their own unique set of circumstances and preferences regarding estate planning.
A retirement plan is very complex and should be discussed with a lifestyle financial planner who should incorporate cash flow modeling into the advice process. There are too many calculations and scenarios to run for this to be done with a pen and paper with any real accuracy.
What is Cash Flow Modelling?
Your retirement income needs to last as long as you do. Using powerful software, a financial planner is able to build financial plans using an intuitive system which allows them to forecast income, assets, and liabilities throughout the lifetime of an individual. This gives an individual a graphical picture of their financial future.
Different scenarios can be run to see how sound a financial plan is when put under various stresses.
Cash Flow Modelling will highlight the shortfall in a retirement plan (i.e. when funds will run out). It can also show the opposite, encouraging an individual to spend some of their hard-earned money with the peace of mind they will not run out of funds in their lifetime.
Do you need to take inflation into account?
Yes, as prices tend to rise over time. This will have a significant impact on the purchasing power of your pension funding in the future. Cash flow modeling allows a rate of inflation to be set which will show the impact of this on your retirement financial plan.
Although inflation is an important factor, research shows that it doesn’t have as big an impact in retirement as you would think, as spending tends to slow down in retirement at about the same rate as inflation, however, this may change in the future and cash flow modeling can illustrate how this would affect a retirement fund. Even a slight increase in inflation can have a dramatic effect on the overall plan.
What investment risk do I need to take with my pension?
An adviser should determine your appetite for risk as part of the financial advice process. In doing so, an advisor will be able to select a realistic rate of return over the long term. Cash flow modeling software will show the compounded effect of this on pension funds.
The software may highlight that a client may need to take more investment risk to achieve their desired retirement lifestyle. It can also highlight the fact that an individual may not need to take an undue risk as they already have sufficient funding levels.
The software coupled with the experience of a qualified and knowledgeable financial advisor can demonstrate a client’s capacity for loss by simulating the impact of lower than expected growth rates or a how a sizeable downturn in global equity markets would affect a financial plan.
This software is there to give an indication of how future cash flow will look and will not be exact due to fluctuating investments and unexpected events.
The cash flow forecast should be a living document that is reviewed with clients every year to ensure they are keeping on track to reach their financial or retirement objectives.
Want to find out more about retirement planning?
Contact us if you would like to discuss your retirement plan to ensure you are on the right track to your desired lifestyle in retirement.