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.
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.