Not only are many retirees getting out of or planning to get out of the rat-race and retiring earlier, but they are also living much longer, on average. A real double Whammy if ever there was one. The same amount of money to last
a lot, lot longer.This is particularly so when you’re looking to finance your own retirement! In such circumstances, it’s fair to say that this New Retirement period could potentially span the length of an average career. Not getting professional advice at this crucial stage in one’s life can leave you with huge problems. This is a Key Decision Time.
In last week’s blog, I touched the Public and Private Sectors and discussed the different options available to both. I outlined in that blog, why those in the private sector really need guidance and advice. To put this in context, let’s look at a 60 year old private sector individual looking to secure a €36,000 pension for the rest of his/her life. Excluding any State Pension entitlement, s/he would need to have accumulated a fund of €1,880,642 to pay for this. (Figures assume a 60 year-old retiree, 3% escalation, 5 year guarantee period and 50% spouse pension). Not an easy task, by any stretch of the imagination.
Today, I am going to focus on this private sector. On all those with executive schemes or personal type pension arrangements over these next few blogs.
So, let’s assume you would have built up a pension fund over the years through your own tax-deductible contributions. This fund now has a value of €600,000. You can choose to retire this pension fund at any age from age 60 (you can retire from age 50 under certain circumstances with certain pensions and even earlier on grounds of serious ill health). You don’t have to stop working and can continue earning if you wish. You must retire your pension before age 75 so you have a 15 year gap when you can choose when to retire.
Let’s say like most people, you want to exit the rat race early and are planning to retire at 60. The 1st option you have which most go for is to take a tax-free lump sum of 25% of the total fund. In this instance, that would be €150,000 in your back pocket. For more info, look up A Guide to Personal Pensions under Resources on my website www.lifestylefinancialplanners.ie . With the balance of €450,000 you really have 3 main choices. 1) Give this money to a life company who will provide you with a guaranteed pension for the rest of your life (called an Annuity). 2) Invest this €450,000 in an Approved (Minimum) Retirement Fund, an A(M)RF, but more on this next week. 3) Split it up and take a combination of 1 and 2.
That’s it, Easy I hear you say! Well almost, but not quite. Most people I know can get it to here, but then tend to switch off.
Well here goes and as agreed, I am only going to look at the annuity option today. If you choose to give your money to a life company to provide you with an income for the rest of your life, you are then buying an annuity (a pension). If you do this at age 60, you will currently get a rate of approximately 3.5% and that would provide you with an income for the rest of your life of €15,750. Not bad if you live until you’re 100 because remember, this income is guaranteed for as long as you live. Not so good however if you died at say 63 because when you die, your pension dies with you. Basically, the actuaries who are quite good at figures, work out the average life expectancies and build in a margin. Thereafter, the funds from those that die younger are used to subsidise those who live longer.
Have you any options other than taking this 3.5% rate at age 60 as mentioned above? Well yes you have, but as you’ll see, there’s a price to pay.
Guaranteed Period – You can choose to build in a Guaranteed Period, whereby if you die before this period expires, your full pension income will be paid to another for the rest of that term. Normally people choose either 5 or 10 years with 10 years being the longest guaranteed term currently available. So, for example, if you chose 5 years and died at age 63, your pension is paid for another 2 years. But like everything else in life, this option isn’t free. A 5 year guarantee will reduce you rate down to 3.47% or €15,615 per year. Choosing the 10 year term will reduce it further again down to 3.44% or €15,480 per year.
Pension Indexation – So, you’re ok to here. But now you’re thinking this €15,750 or slightly less if I choose the guarantee is sufficient for my needs today, but what about in 10 or even 20 years-time? Inflation would mean it wouldn’t be worth a fraction of that! Well, you can solve this by building in an indexation rate at say 3% per annum. In this case, your pension income will rise by 3% every year for the rest of your life. Super, but like everything else, this option isn’t cheap. If you choose indexation, your 3.5% rate to begin with will now drop to 2.235%. So, while your pension income will increase year on year, your pension starting off today will now be just €10,019 per annum. Pain today for pleasure tomorrow
Spouses’ Pension – Suppose you’re married and your spouse doesn’t have any pension income in their own right. Now you’re thinking that if your spouse outlived you, you’d like him/her to receive a pension after you die for as long as s/he lives. Of course you can have that and you can choose the % split you’d like the better half to receive, but guess what happens? 100% correct, your rate drops again.
Impaired Life Annuity – One of the few instances where the life company will actually increase the rate being offered. This is because your life expectancy is calculated as being shorter than the average. You will need to notify the life company of your illness or condition however, as otherwise you will receive the very same low annuity rate as everyone else.
So, loads of options as you can see but every one of them coming at a price. In addition, the starting off rate isn’t very attractive to begin with and not looking like improving any time soon either. Annuity rates are primarily determined by Life expectancy, yields on Government Gilts/ Corporate Bonds and Interest Rates. None of which, from an annuity perspective are currently in your favour. Because of this, it’s little wonder that most people who have a choice aren’t taking up the option of buying an annuity today. They are typically going for the A(M)RF route instead. I will cover Approved Retirement Fund’s in my next blog.
In summary, annuities rates are close to being as low as they have ever, ever been but this doesn’t mean they’re not suitable for some. For example, if you’re single and in good health with no one in mind to leave assets to, you might want the comfort and security of having a guaranteed income for as long as you live. We quite often come across old guaranteed annuity pension contracts which in a previous era offered guaranteed rates of 11%. If you have one of these contracts, you will almost certainly want to take the annuity offered. Where else are you likely to get an 11% guaranteed return on your investment? Before you make any decision, get in touch with a Certified Financial Planner today.
Are you nearing or about to retire, and would like to know what options are available or best for you? If you have any queries on this subject, please email paul@lifestylefinancialplanners.ie
This is an important stage in planning the rest of your life. It’s vital you get best advice now more than ever. Contact us to arrange your free Discovery Meeting consultation today.
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Paul is the Managing Director of Lifestyle Financial Planners Ltd and been in the Financial Planning business since 1985. Lifestyle Financial Planners offer specialist, tax-efficient wealth management, retirement and estate planning solutions to our clients. Paul is a Certified Financial Planner and holds a Masters Degree from UCD in Financial Services and Risk Management.
Tel: 096-75951 Mob: 086-8053755, www.lifestylefinancialplanners.ie
The information contained in this article is for general information only. It cannot be relied upon as the basis for any form of agreement or advice. We advise readers seek separate tax and legal advice where necessary. The information given is a guideline only and does not take into account your own particular circumstances.
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