Don't let the sun set on your pension
22nd November, 2022
How long would your current pension support you once you retire – 20 or, 30 years? It is a difficult question to answer, particularly if you are only starting on your pension journey. The truth is it could last a lot longer than you might think depending on how you manage it.
The greatest (and perhaps most extreme) example is the case of Irene Triplett, the daughter of an American civil war veteran, who still qualified to claim benefits from her father’s pension up until she died in May 2020 at the age of 90. This means his pension managed to last a staggering 158 years. Now while this scheme was paid for by the US Government, it still illustrates the unique position a pension plays in providing financial security not only after we’ve stopped working but after we’re gone.
Sadly, most pensions will not be able to provide for such a long period, but the Triplett story does offer insight into how lasting a pension can be for the benefit of you and your dependents at retirement. The ultimate question is, what can we do to try to prolong the lifespan of our pensions?
Forget about the near-term. Markets are constantly full of noise; it seems more so now than ever before. With inflation, interest rates, and geopolitical conflict constantly in the headlines, it can be difficult not to react when markets are falling. As counter intuitive as it may feel, the optimal strategy is to remain invested and stay the course. For anyone whose retirement is 10, 20, or 30 years away, you are said to have a long-term investment horizon, so the impact of a random morning’s market drop, while difficult to digest, will have little impact on your pension when it comes to drawing it down. The problem arises when panic sets in and you remove yourself from the market, as illustrated in the below chart.
Figure 1. Source - Bloomberg,Davy, MSCI World total return as at 22/09/2022; Currency:EUR; relates to the valueof €1m invested on the 01/01/2022
In the above illustration, over a 21-year time horizon, significant returns were achieved for those who remained fully invested as shown on the left-hand side of the graph with the MSCI World achieving a generous 400% return. Conversely, for those whose nerves got the better of them and pulled out at varying market troughs, (potentially missing the 50 best days), the bar on the right-hand side makes grim viewing with an overall loss having occurred. This is primarily due to market selloffs and subsequent recoveries tending to cluster close to one another. Thinking in decades rather than days may seem difficult, but the evidence is clear - it is the best investment strategy. Ultimately, if you want to prolong your pension you need to prolong your investment time horizon.
Contribute as much as you can afford. Contributions to your pension quickly add up and when correctly invested these could translate into several additional years of retirement benefits through the power of compounding. The old legend of compounding being the 8th wonder of the world is perhaps never more evident than seeing how regular pension top-ups may accumulate into a large retirement pot. This is all before considering the relative tax relief advantages that Revenue allows on your contributions. While such relief is limited by ‘net relevant earnings’ of €115,000, someone in their 40’s, for example, could still reduce their taxable income by up to €28,750 (as per Revenue guidance on Tax Relief on Pension Contributions, correct as of November 2022). The percentage of your earnings that attracts relief also increases as you get older, meaning as retirement draws nearer you can claim even more tax relief when topping up your pension pot (as per Revenue guidance on Tax Relief on Pension Contributions, correct as of November 2022). Of course, it may not always be possible to meet the highest contribution rate, but for years when you may have excess income, there are fewer more valuable places to put these funds to work than into a pension. Additionally, investments in pensions are allowed to grow without incurring a capital gain or exit tax liability, allowing the effects of compounding to grow the capital value of your pot and ultimately extend the lifespan of your pension.
Make your pension work hard, without working hard yourself. Constantly checking how markets are performing (particularly in periods of volatility) can be time-consuming and often stressful. Quite often, occupational scheme providers will offer a default investment strategy that has a mix of diversified funds. While a good mix is important, this default approach may not always be the most optimal strategy, particularly for younger pension holders with very long-term horizons. As discussed above, equity markets perform well over the longer term so having the appropriate investment for your risk appetite is crucial when investing in a pension. Moreover, in an inflationary environment with interest rates rising, equities tend to outperform as businesses earnings rise with inflation compared to fixed income where rates remain fixed (Why high inflation makes investing in the stock market a smart move, CNBC, 22nd March 2022). Having a designated adviser ensuring you are appropriately invested can provide the peace of mind that you deserve. Why should you have to work hard to make your pension do the same?
|Equity Indices (in EUR)||2017||2018||2019||2020||2021||YTD|
Source: Data is sourced from Bloomberg as at market close 31st August 2022 and returns are based on total indices in EUR.
Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up. You may not get back all of your original investment. Forecasts are not a reliable indicator of future results.
Warning: The information in this article does not purport to be financial advice and does not take into account the investment objectives, knowledge and experience or financial situation of any particular person. It is not a recommendation or investment research and is defined as a marketing communication in accordance with the European Union (Markets in Financial Instruments) Regulations 2017. You should seek advice in the context of your own personal circumstances prior to making any financial or investment decision from your own adviser. The tax information contained in this article is based on Davy’s current understanding of the tax legislation in Ireland and the Revenue interpretation thereof. It is provided by way of general guidance only and is neither exhaustive nor definitive and is subject to change without notice. It is not a substitute for professional advice. You should consult your tax adviser about the rules that apply in your individual circumstances
Warning: Tax information contained in this article is provided by way of general guidance only and is neither exhaustive nor definitive and is subject to change without notice. It is not a substitute for professional advice. Please note that Davy does not provide tax advice. You should consult your tax advisor about the rules that apply in your individual circumstances.