Irish Financial Review

Despite the Defined Benefit risks, pensions still make sense

By: Frank Conway

If one thing is certain in pensions, it’s this; risk is never far away.

And when it comes to defined schemes, whether Defined Benefit (DB) or Defined Contribution (DC), risk is an inherent feature of what pensions are all about.

Protecting and growing personal wealth

Protecting and growing personal wealth

But DB pension schemes never really made actuarial sense.

Unfortunately for those that relied on them, realising that DB schemes were often built on a foundation of sand came too late. In some cases, beyond the point where they could hope to make up the massive financial black holes their pension pots became.

But all is not lost.

Pension contributions still make a lot of sense. And although DB schemes are on the decline, the rise in DC schemes do make a more realistic replacement option, provided a number of things happen first.

Earlier the better

For anybody in their 20’s today, now is the time to start their own super-saver pension account. I call it a super-saver because of the enormous potential to pack money away and grow it over time through the compounding effect that pension contributions benefit from. And the earlier that one starts one of these accounts, the greater the magic of time.

Let’s take someone in their 20’s, they can pack away 15% of their income (income threshold limited of course) using tax relief and employer matching options which means that even if they take just 5% of their gross salary and receive a 5% match from their employer, they will have doubled their savings, before  the tax relief even kicks in. This is why I call it a super-saver account.

But that’s not all.

Aside from the tax-relief benefit, the money can grow over the years without incurring any tax liability. To put this into perspective, Government usually charges anywhere from 41% on interest income (DIRT) to 33% on capital gains tax. So the offer on saving in this case is extremely generous indeed!

Fees really do matter

But before one gets the idea that all investments are the same, they are not!

First off, one must consider the impact of the investment philosophy. Is an active or passive approach being used and what are the risk-ratings?

I would always encourage a high degree of stock market investment using a mutual funds approach, even in post retirement. The cash amount can be increased but if one expects to live another 20 years in post-employment (or post full-time employment), that money needs to keep on growing!

But it is fees that are the most destructive to wealth growth…much more so than investment risk.

If we take a high-cost fees investment versus a low-fees investment over a 30-year period, the cost difference between fees of 3.5% versus 1.5% would equate to approximately 70% of potential fund growth over that time period (assuming for a 5% annual rate of growth). With high fees, fund growth would be marginal at best and even negative depending on the total cost of fees and charges.

Changing market and better opportunities

Despite a lot of negative news on DB schemes (trust me, there will be more), consumers today can grow retirement income wealth significantly via the DC options (and AVC additions) provided they capitalise on stock market options, plan long-term and control management fees. If they do, they should be in a good position to enjoy their retirement years in relative financial health.

3 things to practice with your money

Over the years, having moved between different aspects of money, there is one thing that I hear a lot:

Oh, I could really do with some money advice.”

Image result for money details

Modesty is an essential element of staying in control of one’s personal finances

With interest, I usually ask what specifically they want to know and the answers range between a form of shy guilty “I should know more” to a sort of a ramble about saving and money management.

A big problem when it comes to money is that a lot of people seem to think it is much more complicated than it really is.

The financial industry has not made things easy. In fact, in some cases, the development of a coded financial language is testimony to this communications barrier.

For example, when it comes to pensions, the number of acronyms is simple bonkers; PRSA, AVC, DB, DC, OPS, ARF, BOB, AMRF, TER, OCF!

With so many acronyms, one would think the industry was designed by the US military!

Setting the scene

For those interested in their long-term financial well-being, there are some very simple steps which they can take:

  1. Be informed – money isn’t complicated. There is an endless supply of available information on products and services. But even when it comes to personal money management, simply reviewing and tracking spending is a great way to getting to grips with where your money goes, what you spend your money on and areas of spending that some fat can be eliminated.
  2. Be patient! When it comes to planning for both large and small spends, it is important to allocate the time to developing, implementing and maintaining a plan.
  3. Be modest – if you do not understand something, ask! This applies across the board. Don’t understand something on a home insurance policy? Ask! Don’t understand a phrase on a Life policy? Ask! And ask again and again and again until you understand. Remember, it’s your money, be comfortable that you understand what you are spending it on. And never forget that the only person that really cares about your financial well-being is you! So you need to make sure that you understand the details of what you are spending your money on and the products you are investing in!

Money is not complicated. And, as more and more of us are predicted to live into our eighties and beyond, it is now more important than ever we take the time to be in control of our money. This is best achieved through education, preparation and determination.

Ollie – the money magazine for kids

Here it is. First for Ireland. First financial literacy project developed for kids aged 7 – 11. First that promotes critical thinking. First that supports adults on how to have a money talk with their kids.

Ollie is free to schools and adults (and kids too!!!).

To get your free copy, order using the form below

Ollie - the money magazine for kids aged 7 - 11

Ollie – the money magazine for kids aged 7 – 11

To order Ollie, simply use the form provided below

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