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Darach Honan: Prepare for the ‘pension time bomb’

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There are choices you make in life that will have a huge impact on your future, writes financial advisor Darach Honan. Starting a pension for your retirement is one of those choices because the earlier you start the brighter your future. It doesn’t cost as much as you think. Tax relief is by far the greatest advantage of saving in a pension.

If you’re paying tax on your salary at the highest rate, then you’re entitled to get a 40% saving on any pension contributions you make.  If you are a higher rate taxpayer a contribution of €120 from you, plus €80 tax relief from the government will give you a gross contribution of €200 to your pension. While this tax incentive is really appealing, incredibly only 1 in 3 private sector workers in Ireland are contributing to a pension. So, while your friends in the public sector: teachers, nurses or doctors, automatically pay into a pension to provide for their future, those in the private sector are lagging.

In Ireland, pensions are a ticking time bomb and all across the political spectrum we see those who wish to kick the can down the road. The ‘pension time bomb’ refers to the major issue that the state will have in providing people with state pensions in the years ahead. The pension reserve fund was used to bailout the banks in 2010 leaving reserves depleted. Currently, there are five people working in Ireland for every one who is drawing the state pension. By 2055, it is projected that there will be only two workers for every one who is drawing the pension. State pension payments and age of qualification as it currently stands is completely unsustainable into the future. It makes it more concerning that there seems to be competition amongst politicians as to who can offer to reduce the pension age the furthest and increase the payments the most.

This sort of short-term thinking is what should concern people of a younger generation as to what will be available to them when it comes to claiming a state pension. It will be the case that if you wish to retire in your 60s you will have to build up your own pension fund as you may not be able to rely on the state. The earlier you begin this the better. Over a 40-year period, a 25-year-old will generate a 60% larger pension than someone who starts 10 years later. Over the same period, they will generate 180% larger fund than someone who waits until they are 45.

*Take the example of someone who contributes €200 per month to their pension. If they begin at age 25, they will finish with a pension fund of €190,990 at age 65. The 35-year-old who makes the same contributions will have a fund worth €119,239. The 45-year-old who contributes €200 per month will have to make do with a pension fund of €66,985. These significant variances will play a huge part in how early an individual will be able to retire.

Talk to your financial advisor in order to plan your retirement. As demonstrated above, how fast you take this first step will have a major impact on your options later in life.

*Assumptions: These figures assume a Gross investment return of 4.2%, 100% Allocation rate. 1% AMC. Level premium of €200 per month

Darach Honan is a financial advisor with IPS Financial Advice Ltd in Limerick. Contact Darach on darach@ipsfa.ie or call 087 1277155.

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