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Pension Options for Retirement

Kevin Connolly
March 2003

How much will you need to live on when you retire?


Some Points:

  • Life expectancy is increasing all the time.
  • 65 year old man can now be expected to live for another 19 years and women of the same age for a further 22 years.
  • You should be planning for several decades of retirement now.
  • Retirement does not mean taking to the chair in the corner but it should mean that you don’t have to work as hard to give you an income to enjoy.
  • In retirement you will have twice as many hours of freedom and nothing like as many parental responsibilities.

While you are working you probably don’t think too much about your retirement- but unless you plan for it during your working years you may be left without sufficient resources to enjoy a comfortable lifestyle once you retire.


Pension Options At Retirement


4 forms of pension income:

  1. Non-Contributory Old Age Pension
  2. Contributory old age pension
  3. Personal Pension Plans
  4. EU Farm Retirement Scheme


1) Non-Contributory Old Age Pension

This is a means tested payment for people aged 66 or over who do not qualify for Retirement Pension or Old Age Contributory Pension based on their social insurance record.

This was the typical source of income in retirement for farmers up to a few years ago.

Means test

To qualify for payment, you must satisfy a means test. Your means are any income you or your spouse / partner have or property (except your own home) or an asset which could bring in money or provide you with an income.

The Means Test takes account of:

  • Cash Income
  • The value of any property personally used by you i.e. farm (Home is excluded here)
  • The value of any investments or capital held
  • The means of any spouse or other person cohabitating with you

The means is calculated on a sliding scale of €X per €1000 of the income and capital above.

Payment received from the Department of Agriculture, Food and Forestry under the Farm Retirement Scheme is not assessed as means. However, this payment may be reduced by the amount of your Old Age (Non-Contributory) Pension.

The yearly value of any advantage you or your spouse / partner have from owning or leasing a farm of land is assessed as income. The yearly value is worked out by deducting any necessary expenses incurred from the gross income.


2) Contributory Old Age State Pension

From 1988 the self-employed, including farmers, pay ‘S-Class’ PRSI.

To qualify for this pension you must have made PRSI contributions and have met certain conditions.

NOTE: You can claim Old Age (Contributory) Pension at age 66 and continue working.

To receive a full pension you:

  • Must have started paying PRSI before reaching age 56
  • Must have at least 260 weeks of insurable employment in which contributions were made if retiring between April 6, 2002 and April 6, 2012
  • Yearly average of 48 weeks full rate contributions paid for period from April 5, 1979 to end of tax year before pension age is reached

A yearly average of 10 contributions is required for a minimum rate pension.

For the maximum pension an average of 48 weeks contributions is needed – 10 years contributions.

There are also increases for child dependants under the age of 18 living with you.

  • This pension is not means tested, so assets such as property, investments and savings can be retained without affecting the pension.
  • Can apply for pension five months from 66th birthday.

NOTE: Where farmers join the EU Farm Retirement Scheme they should make provision to continue their PRSI contributions so as to retain eligibility for the Contributory Pension.

Can become a voluntary contributor if you have at least three years paid under compulsory ‘Class S’ PRSI and apply within 12 months of year in which last compulsory payment was made.

Minimum flat rate voluntary contribution is €254.

To become a voluntary contributor you must complete application form VC1.

If you are in the EU Farm retirement scheme and are eligible for a Contributory old-age pension then the EU pension will be deducted from the ERS pension.

Check the current rates of the State Old Age pensions.


3) Personal Pension Plans

These are savings plans designed to yield a fund on retirement, which can be at ages 60 to 75 years.

A personal pension allows you to build up a large cash fund in a tax efficient manner for retirement.

ESRI report in 1995 – only 13% of farmers had provided for retirement through a recognised pension plan.

Income from a personal pension will not interfere with the EU Retirement Pension.

There are two phases of planning for retirement:

  • accumulate as much of a cash fund as possible while you have an income up to retirement age
  • preserve the value of this accumulated fund and use this to the best possible advantage thereafter so as to provide you with an income during retirement.

The cash fund will be made up of the contributions made, together with the returns from the investment of these contributions over the years.

The size of the fund will depend on

  1. when the fund was started and the total value of contributions
  2. investment strategy
  3. growth rates
  4. tax reliefs.


1) Time of starting fund

  • Look at your needs for cash now and in the near future and contribute as much as you can without sacrificing your current standard of living.
  • Don’t sacrifice essential expenditure now for an uncertain payoff in 40 years time.
  • Bring mortgage under control, pay off any high interest debt and then look at your pension contributions.
  • The earlier you start the more you will have contributed at the least cost over the period. The fund will also have greater potential to generate growth.


2) Investment Strategy

The investment strategy will determine the growth potential of the cash in the fund.

Different types of fund will carry different levels of investment risk and so will give different levels of return.

  • Cautious Strategy - cash or gilts (government bonds)
    Suits those retiring soon or with low risk threshold
  • Measured Investment Strategy - equities, property and government bonds
    Some level of underlying guarantee
  • Active Investment Strategy - greater emphasis on equities
    No underlying guarantee
  • Aggressive Investment Strategy - Risky but with potential for higher returns
    Normally totally equity based
    Suitable for early years of working life or if you have a high tolerance to risk

3) Growth Rates

Fund growth rates will have a major bearing on the size of the fund at retirement.

The following results are from The Irish Times Personal Pension Survey (November 2, 2001)

Best and Worst fund performance based on a fund taken out on January 1, 1981
and maturing on January 1, 2001 with annual contributions of €2,000
Fund Net Yield (% pa) Maturity Value Difference
Fund A 15.95% €337,613 €103,789
Fund B 13.05% €233,824

Remember the old saying: ‘Past performance is no guarantee of future growth’.


4) Tax Relief

The maximum contributions on which tax relief can be claimed are as follows

% of net relevant earnings
Under 30 years of age 15%
30 to 39 years of age 20%
40 to 49 years of age 25%
50 years of age and over 30%

Relevant earnings consist of earned income from employment.

Unearned income such as rental or investment income is not included for relief.

Net relevant earnings are relevant earnings less capital allowances & trading losses.

For someone on the high rate of income tax (42%)

  • Each eligible €100 invested in a pension fund only costs €58. In effect the Government gives you back €42 in tax-relief.

The maximum benefit is received if you are paying tax at the higher rate.

Other tax relief is gained on retirement as 25% of the fund can be taken as a tax free lump sum.

Remember it is more correct to view the tax treatment of a pension contribution as tax deferred rather than tax saved. You will have to pay tax, at your top-rate, on your income from the fund upon retirement.


NOTE:

The pension from the EU Retirement Scheme or income from the leasing of land is not regarded as relevant earnings. If no relevant earnings are available then the fund can be deemed ‘paid-up’ and remain and grow until retirement age.

A retired farmer could earn income outside of farming and this could be deemed relevant earnings from which contributions could be made.

Also there could be the option of the transferee paying a consultancy fee to retired farmer, which he could declare for tax purposes, and continue to make contributions from.


Charges

  • Watch out for initial charges (upfront commission) for set up- can be 3-5% in some cases.
  • Contribution charges for each contribution, sometimes called a ‘policy fee’ range from €2.50-€4 per month.
  • On-going management charges on the fund can vary from 0.5% to 2%


What happens when I retire?

  • You can take up to 25% of your pension fund as a lump sum tax-free into your hand.
  • You have three options with the remaining 75% of the fund
    • Buy an annuity
    • Invest in an ARF and/or an AMRF
    • Take it in cash and pay PAYE tax at the marginal rate


Annuities

An annuity is a type of pension that can be bought from a pension provider using the remaining money in the pension fund. In exchange for the money in the fund the pension operator will provide the pensioner with a taxable pension income for the remainder of his/her life.

The type of annuity you pick will determine the income you will receive throughout your retirement.

Annuity Types

  • Standard annuity
  • Single or Joint Annuity
  • Indexed annuity
  • With-profits annuities.


Standard Annuities

The fund is used to buy gilts (Government Bonds), which pay out a fixed but relatively low income. The interest rate on these is linked to general interest rates.


Single or Joint Annuities

Single life basis annuities – spouse is left high and dry if you die first.

If you have a dependant spouse then aim to provide them with at least half the annuity income when you die.

This will cost you by reducing your annuity rate.


Indexed Annuity

Where benefits will increase by a fixed rate normally around 3-5%.

Will be balanced by starting your pension at a lower initial level of benefit.


With-Profits Annuities

Your fund is used to invest in equities while providing stability by holding money in reserves as a capital guarantee. You will get a better return when markets do well but a lower return if they do badly.


Impaired Life Annuity

If you have a serious condition which will curtail your lifespan. The annuity will cease when you die but it can be set up at a substantial discount initially.

Factors that determine the size of your annuity pension include:

  • the amount of money in the fund
  • your age at retirement (or the age that you set up/avail of the annuity)
  • interest rates

Returns from annuities have been low in the last number of years due to low interest rates. Low interest rates mean that the life assurance company can earn less on its fixed interest investments so less money is available to provide pension income.

NOTE: You can shop around for an annuity from a different company than that with which you had the original pension fund.


Approved Minimum Retirement Fund. (AMRF)

This is a fall back position for individuals who are otherwise not well provided for in terms of retirement income.

If you don’t have a guaranteed income of €12,700 a year you must use the first €63,500 to buy an annuity or you must invest it in an AMRF.

You can only draw down profits from the fund. The initial investment cannot be accessed prior to the earlier of death or age of 75. At age of 75 the fund switches to an ARF and you can draw down the whole fund as it suits you.

NOTE: You should make sure you have qualified for the Contributory Pension, as this will prevent you having to set up an AMRF. This means that you will have the flexibility of setting up an ARF with the whole fund.


Approved Retirement Fund (ARF)

Unless you badly need the cash immediately on retirement you should set up an ARF rather than take the balance of the fund as cash.

An ARF is an investment fund which can be invested whatever way you wish- so there is a greater sense of control over the future retirement income.

An ARF is a tax-exempt fund- no income tax or capital gains tax is liable on the growth of the fund.

You can draw down an income from the ARF whenever you want and when it is most tax efficient e.g. up to the limit for the low rate of tax.

An ARF is provided by a qualifying manager - stockbroker, bank or life insurance company.

Ideally you should select a fund that will give both security and high growth rates long-term.

Unlike the annuity option you have the facility to pass the remainder of the fund on to your surviving spouse or children when you die, without any Capital Acquisitions Tax liability.


Personal Retirement Savings Account (PRSA)

A PRSA is a long term Personal Retirement Savings Account.

The Pensions Board will supervise PRSA providers.

There have been six providers named already (as at 20/03/03).

There are two types of PRSA- a standard PRSA and a non-standard PRSA. The main difference between them is that the maximum charges under a Standard PRSA cannot exceed 5% of contributions paid and 1% per annum of the PRSA assets.

Charges for the non-standard PRSAs may vary depending on the product.

Some of the other features include:

  • No charges on transfers to another PRSA or pension scheme
  • No charge for stopping and then restarting contributions
  • Low minimum contributions

Maximum allowable contributions for tax relief in PRSA
% of net relevant earnings
Under 30 years of age 15%
30 to 39 years of age 20%
40 to 49 years of age 25%
50 years of age and over 30%
Note that these maximum allowable contributions are the same as for conventional pensions as outlined above.

Equity Release Products

These are products that allow older people to cash in on the value of their homes. With rising property prices over the last number of years people can have a substantial amount of equity built up in their homes. With falling pension funds many people are looking to cash in on this equity. One such way is to borrow against the property value.

Up to 30% of the value of their home can be borrowed at a fixed rate with no repayments made until they die, move out or sell their home.

Interest rates tend to be high (7.5% APR versus 5.8% for home loans)- so the proceeds on the sale of the house on death may be well eaten into when both the initial capital plus the interest repayment is made. The net result is that the borrower gets up to a third of the money in cash and the bank could get over half of the original value in interest. The rest of the proceeds pass to the estate of the deceased.