BY JOHN ELLIS, FINANCIAL ADVISOR
It’s nearly tax return time again. It’s the time when people look at their pensions and what amount they should contribute. For many their pension contribution is determined only by the tax saving they can make. But there’s more than tax relief at stake. You financial situation in later life is at stake. A useful tool to get a handle of your finances is to calculate your net worth. This will help you evaluate your current situation, set goals and budget for retirement.
Net worth is the whole picture, evaluating what you owe, what you own and how much money you really have. If you want to set a net worth goal for retirement the figure you use should accommodate your lifestyle and limits. There is no one-size-fits-all number for how much money you need to have at retirement.
To get started, look at how much you plan to spend in retirement. You need to estimate the annual amount you will need to have available to pay all your regular bills. For instance, you will need to include housing, (if the mortgage is not paid off) utilities, travel, food, entertainment expenses etc.
You may then decide you want €25,000 a year during retirement to cover the cost of living. The Old age pension will go some of the way if it is still there when you come to retire. But if you plan to travel, or take on other hobbies, these will impact on how much you will need. You might then decide having €30,000 or €40,000 a year would allow you to live your preferred lifestyle.
Your net worth evaluates your overall wealth, but your retirement income will typically come from your most liquid assets. Thus, when you look at the funds available for spending in retirement, focus on assets like cash, stock market investments and pension plans to see how your cash flow will be generated.
A general rule of thumb that is used for retirement planning is known as the 4% rule. This refers to the amount of money you withdraw from a retirement account each year. So, after adding up your available funds, take 4% of that capital amount. That will be what you have in theory to live on. Not a lot in many instances but this exercise should encourage us to see saving for retirement not only as a tax relief function but as an imperative.
Let the Government help you as saving for pension is one of the few areas that there are still generous tax allowances available. If you are paying tax at 20%, then for every €100 a month you invest in a pension you receive €20 tax relief so the net cost to you is €80 a month, within revenue limits. Better still, if your marginal rate is 40% then every €100 you invest you receive €40 back and the net cost is €60 a month.
However, pension planning can be fraught with difficulties and good constant advice is a must. As you save toward retirement and especially when you begin to ‘cash in’ those plans you need to be aware that your retirement fund is not guaranteed to keep its value because the assets in which you are invested may not perform as well as expected and you may not meet the target figure you had planned for.
Again in retirement, outside of an annuity there is a risk that your fund could run out in your lifetime. This could happen if you take income at too high a rate and/or the investment performance of the underlying funds is less than expected or you live longer than expected.
Also tax relief and benefit options can be subject to amendment by governments, and you will pay tax at the standard or marginal rate on any withdrawals. In a sentence, pension planning is for life.