Should I make a pension contribution this year, given the volatility in investment markets?

There are a significant number of benefits to making a regular pension contribution. However, recent investment market volatility could lead some pension holders to question if they should make a pension contribution, before the impending Revenue deadline of the end of October (if filing by post) or the middle of November (if filing online via ROS), in respect of 2014.

Pension benefits

Before considering the impact of recent investment market volatility, it is important to remember the benefits of making a pension contribution. The following points are five key benefits of personal pension contributions.

1. Retirement income

The good news is the majority of us are living longer than ever before. The bad news is that we will need to provide ourselves with an income in retirement for a longer period of time.  In order to fund this additional retirement income, we will need to save more for retirement.  The earlier and more you contribute, the more likely you are to achieve this financial objective.   

2. Income-tax relief

Income tax relief is received on personal pension contributions (RAC’s and AVC’s) within age-related bands.  The maximum remuneration Revenue allow for calculating personal pension contributions is €115,000. The table below outlines the age-related maximum contributions an individual can make based on this maximum remuneration.  For example, if a 53-year old individual with a salary of €250,000 wished to make a personal contribution in respect of 2014, the maximum contribution they could make would be capped at €34,500. Revenue define remuneration as earnings (i.e. for employees, earnings means gross pay of any kind and for the self-employed, earnings means earnings less allowable expenses).

Age             % of Earnings allowed as a contribution (subject to maximum) Maximum contribution based on maximum remuneration
Under 30   15%  €17,250 
30-39  20%  €23,000 
40-49  25%  €28,750 
50-54  30%  €34,500 
55-59  35%  €40,250 
Over 60  40%  €46,000 

3. Tax-free performance

From the point of the pension contribution to the point of retirement an Irish pension is not subject to Irish tax on any investment income or gains it generates. 

This is a valuable benefit, as other wealth-accumulation options such as deposits (DIRT 41 per cent), direct shares (Income tax 40 per cent on dividends and CGT 33 per cent on gains), investment properties (Income tax 40 per cent on rental income and CGT 33 per cent on gains) are subject to tax on a more frequent basis.

4. Tax-free retirement lump sum

At retirement, depending on the pension vehicle(s), an individual can draw down a total tax-free lump sum from all their pension benefits of up to €200,000. A further total lump sum of up to €300,000 may also be withdrawn at the current standard rate of tax (20 per cent), despite the fact that income-tax relief may have been granted at the individual marginal rate (currently 40 per cent). The lump sum you are entitled to will depend on the pension in place and may be lower than the amounts above.

5. State Pension uncertainty

There is no guarantee the State Pension will continue indefinitely. The government have already increased the qualifying age to 68 for individuals born after 1961. The Irish State Pension is paid from annual tax revenue on a pay-as-you-go basis and as the overall Irish population grows older and their life expectancy increases, the ratio of people in work to those in retirement reduces. Therefore, the cost of funding the State Pension in its current guise will increase significantly and further changes may be unavoidable. As such, it is imperative that individuals privately fund for their income in retirement and do not solely rely on the state.

Case study – Investment market volatility

Given the above benefits, contributions to a pension plan on a regular basis over the long term make sense for the majority of individuals saving for retirement. However, given recent market volatility, pension holders may decide to refrain from making contributions until investment markets recover. We have carried out the case study to show that for a regular pension contribution, volatility in investment markets can actually be beneficial for retirement funds over the long term. 

By way of example, if we examine two self-employed individuals who contribute €25,000 per annum over fifteen years. The contributions are invested in two separate fictional defined contribution unitised funds, Fund A and Fund B. The unit price for each fund is the same on day one and by the end of the 15-year period the unit price of each fund is also the same. 

During the 15-year period the unit price for Fund A increases by a fixed 5 per cent per annum and the unit price for Fund B fluctuates on an annual basis by up to plus 30 per cent or minus 20 per cent. 

The graph attached outlines the difference between the unit prices of the two funds. Fund B is subject to a significantly higher level of volatility over the 15-year period, but each fund has the same unit price at the end of the period.

Unit price

What fund would you pick?  Fund A may be tempting due to the consistent five per cent return on an annual basis. However, fund B actually resulted in a retirement value that was approximately €64,500 or 17 per cent higher than Fund A, as illustrated in the attached graph. Despite the exact same contributions being made and the short investment period relative to normal pension investment periods.  Fund B is superior as more contributions are used to purchase units at a lower unit price than Fund A.

The old adage buy low and sell high would appear to apply in this scenario. If you would like to discuss any aspect of this article or are considering a pension contribution, please contact one of Deloitte’s Pension and Investment team.

Please note the above example does not take all factors into account. It does not constitute advice and should not be relied upon in any way. If someone is considering making a pension contribution they should contact their financial adviser to discuss their financial circumstances and whether a pension contribution is appropriate.

Retirement value
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