Wisdom is: Starting your pension funding early

The eyes of young people often glaze over when the subject of pensions is raised. After all, pensions are for old people, aren’t they? Well yes, the payment of pensions only happens when you retire. However to get to that point, you need to build up a pension fund. And that certainly is not a task for old people, in fact it is very much a young person’s game! Starting your pension early in life has numerous benefits.

Tax relief

None of us enjoy paying tax. Yes, we understand it is a necessary evil if we want our country to function, but we all want to legitimately reduce our own tax burden, and funding for a pension is probably the most effective way of doing so. If you are a 41% tax payer and decide to put €1,000 into a pension, the government are effectively contributing €410 to your pension as a result of the income tax avoided. So you want to start benefiting from this important tax break as soon as you possibly can.

Tax free growth

In addition, pension investments are not subject to DIRT tax. If you save in a bank, any interest earned is immediately taxed at 41%, significantly reducing the growth of your money. However pension funds are not subject to DIRT tax, so your investment builds up free of taxes. So again, availing of this important tax advantage as early as possible will deliver significant long-term benefits.

You can achieve more with less…

Well it’s probably quite obvious but the longer that you pay into a pension fund, the more you can expect to receive when you retire and the more likely you are to achieve your financial goals. Be realistic about how much it will take to achieve your goals. As a rough rule of thumb, you should aim to save “half your age” so if you’re 30 years old, you should aim to save 15% of your income each year from now until retirement to build up a decent fund. If you wait until you are aged 50 to start, you should then aim to save 25% of your income each year. Of course, this is only a rough calculation. We will help you develop a far more tailored picture for you, taking account of any existing benefits that you’ve already built up and will help you to implement a plan that is right for your particular circumstances.

You can probably take on more risk

A contribution made to a pension plan in your 20’s or 30’s has the benefit of time on its side to grow very significantly from the time it is made, to your retirement age. And because you have this time on your side, you will probably be more willing to take some risk with your funds, with the aim of achieving higher growth rates.

These higher growth rates may be achieved through investing in the likes of equity (stock market) funds. If you had invested in the S&P 500 Index of shares from 1stJanuary 1985 to 31st December 2014, your investment would have achieved a Compound Annual Growth Rate (annualised return) of 11.40 per annum over the 30 year period! Now of course previous returns are not necessarily a guide to future performance, but they give a sense of what can be achieved over a long timeframe. And on top of this, you then have the impact of compound interest…

Compound interest has a huge effect

The “Rule of 72” is a simple maths equation to determine how long an investment will take to double, given a fixed annual rate of interest. All that you have to do is divide 72 by the expected rate of return. The answer is the number of years it will take for the amount of money to double.

  • If you are young, aiming for a return of (say) 8% p.a., it will take 9 years for your investment to double (72/6% = 9 years)
  • However if you are older and rightly more cautious, you may only be aiming for a return of (say) 3% p.a. In this case it will take 24 years for your investment to double (72/3% = 24 years).

So starting early, having the opportunity to take on a bit more risk in the hope of achieving higher returns and then having the benefit of time can have a seriously positive impact on your pension fund. It really is a case of starting sooner rather than later! And then hopefully when retirement comes around, you’ll be able to put the feet up and enjoy your wisdom of youth!

Photo courtesy of Gerald England


20th October, 2015

Posted In: Advice, Financial, Insights