Many people find pensions scary. We know they are important but it’s easy to be overwhelmed by complicated terminology and slick salespeople. But ignoring a pension is damaging to your long-term financial security, and even a delayed start surrenders your biggest advantage. Read on to learn more…
A pension is a mechanism to save for the future - a savings plan wrapped up in rules, regulations and tax laws. But it’s easier to think of it as a bucket - money goes in, earns returns and grows over time, and is eventually withdrawn (or passes to your estate).1 While there is lots more detail in the background, if we stick with this analogy, all the complexity falls under one of those three steps.
Contributions - Money Going In
You make personal contributions, ideally on a regular basis, and if you’re lucky your employer might add some too. Significant tax breaks provide an extra incentive to save. Starting small is fine, particularly if you are young, but if you gradually increase your contributions it will make a big difference over time.
Growing Over Time - Returns & Investment
Unless you are very wealthy, it’s going to be almost impossible to actually save enough for retirement. This is why investment returns are important. With a long enough time horizon (20 / 30 / 40 years) even small annual returns will compound into big gains. It’s tempting to chase high returns, but this is very hard to achieve (and not something you can control), whereas allowing time to work its magic is fully within your control and can be almost as impactful. Stay tuned for a future post on this.
Withdrawal - Money Coming Out
This is when the years of sensible saving pay off. There are many rules about how much you can withdraw and when, and all are mostly intended to protect you. But you don’t need to worry about these until you get close to retirement age and EVERY one of those decisions is made easier and better if you have made good choices at Steps 1 & 2 beforehand.
The main benefit of pension savings is the tax treatment. The money going in avoids tax (which is a major bonus) and the fund grows over many years tax-free, all on the understanding that you pay tax on the withdrawals. This is a very good deal for you - it’s better to pay tax in the future than now, you may be in a lower tax bracket when you retire so you’ll pay less anyway, and you can even withdraw a big chunk tax-free. And while there’s no guarantee that future tax laws won’t change, that remains true regardless and it’s better to face that having not paid tax already!
So what else should you know:
You’re going to need more pension savings than you think, even if you’re a member of a scheme at work or are a public sector employee expecting a State-funded pension. Here’s why.
The impact of the tax break is so significant that it deserves a separate post to emphasise - stay tuned for that also.
Finally, your biggest advantage when it comes to pension maths is time. It’s hard to fathom just now much returns can add up over a long time, though I will attempt to explain this better in another forthcoming post.
In summary, pensions aren’t exactly exciting but starting one is probably the easiest and most reliable step you can take to safeguard your future financial security.
This post is the first in a series exploring pensions in more detail - subscribe if interested, share with family or friends who may benefit, and comment email or tweet with any feedback - all is welcome.
Public-sector pensions and some older defined benefit pensions are different, but this post is primarily concerned with defined contribution or private pension plans. If you don’t know what these are, just stay tuned for future posts.
Hi, thanks for the post! I came into Ireland a few months ago and don't have yet a retirement scheme set up. I have many, many questions, and am looking forward to the next posts :)