Personal pensions, also known as Retirement Annuity Contracts, are intended to enable self-employed individuals to save for retirement. As with most other pensions, contributions are eligible for tax relief at source, making personal pensions an attractive means of reducing tax liability as well as saving for retirement.
This type of pension has to some extent been superseded by PRSAs (Personal Retirement Savings Accounts), which have a more transparent charging structure and more flexibility but otherwise have most of the same advantages. However a personal pension may still be a sensible solution for an individual looking for fund choices that are unavailable under a PRSA contract. For those making large contributions, it can be possible to obtain a more favourable charging structure under a personal pension than under a PRSA.
Eligibility for personal pensions
To contribute to a personal pension, an individual must have “Relevant Earnings”. Relevant earnings are earnings from a job where the employer does not provide an occupational pension scheme, or from a self-employed trade or profession.
Contributing to a personal pension
Contributions to a personal pension are limited by your age and income level. Contributions are eligible for relief from income tax, PRSI and the health levy. This relief is normally claimed back from the Revenue in your annual tax return.
Charges for a personal pension
Charges for personal pensions can be complex and inconsistent. Partly for this reason PRSAs, which have more transparent charging structures, are becoming more popular.
Benefits at retirement
At retirement, you will be able to take 25% of your accumulated personal pension fund as a tax free lump sum, up to a maximum of €200,000. The balance may be used to purchase a guaranteed income for life (annuity) or, subject to restrictions, it can be transferred to an Approved Retirement Fund (ARF). In certain circumstances the balance after tax free cash can be taken as taxable cash.
Determinants of level of benefits at retirement
A number of factors will influence the level of benefits you may receive from your personal pension at retirement. These include:
- Your level of contributions
- The investment performance of your chosen fund or funds
- The age at which you take your benefits
- The level of annuity rates when you take your benefits
Investing your personal pension
There are a variety of funds available within personal pensions, including high risk, medium risk and low risk options.
In general, the higher risk a fund, the more the growth that can be expected from it over the long term. However high risk funds are also volatile, and will experience many ups and downs over the course of investment. Low risk funds will be much less volatile, but will also probably deliver much lower long term growth.
It is usually considered appropriate to invest on a medium or perhaps even a high risk basis when you are a long way from retirement. After all, if markets fall in value, it means that your new contributions will buy in at a cheaper price. Thus a fall in value can actually be good news when retirement is a long way off.
However when you are closer to retirement it can be sensible to reduce risk. You may wish to consider investing in a “lifestyle fund” which will automatically reduce risk as your indicated retirement age approaches.
Investment return expectations
If you invest in a low risk cash fund, returns are likely to be no higher (and may be lower) than short term deposit interest rates. If you invest in a high risk equity fund, it may be reasonable to expect average returns over the very long term of 4 - 6% ahead of inflation. In other words, if inflation averages 2% per annum, then the average expected return on a high risk equity fund would be in the range 5-7%. However higher risk funds will experience years of much worse and much better returns than this broad average would suggest.
You may want to find out more about the principles behind saving and investing. These principles are, in general, similar within a pension fund as outside of one.
Annuity rates and their relevance
An annuity is an income for life. Annuity rates are the prices at which life assurance companies will sell you an annuity.
At retirement, if you use your pension to buy an annuity, the level of income that you receive will be determined by the following factors:
- The size of the pension fund that you have accumulated
- The annuity rates at the time
- Your age when you buy the annuity
Age at which benefits can be taken
Normally, you can take your retirement benefits from a personal pension at any time after the age of 60. There is no requirement to adhere to your originally selected retirement date. It is possible to take early retirement in the event of serious illness. As a general rule, if you intend to buy an annuity, the older you are when you take your benefits, the higher the annuity you will be able to buy, as annuities are less expensive for older people.
Death before retirement
If you were to die before retiring, the value of your personal pension would be payable to your estate.
Tax on Personal Pensions
In the past, not only have contributions to personal pensions benefited from tax relief, but the fund itself has been allowed to grow free of tax. However a pension levy has applied at differing levels since 2011 and it is projected to continue until at least 2015. The levy as announced by government has been 0.6% in 2011, 2012 and 2013, 0.75% in 2014 and 0.15% in 2015. It is unclear whether a levy will continue to apply after 2015 or not.
Mercer can help
Mercer is Ireland’s largest administrator of occupational pension schemes. We have also achieved authorised advisor status. We are well positioned to help you to choose a personal pension that is right for you, or, if appropriate, to advise you on alternative options such as a PRSA or an Executive Pension.
We can also give you a second opinion on your existing personal pension arrangements, advice on whether a personal pension is the right option for you or which personal pension to choose.