What Is An Annuity?

Many people will have heard pension conversations mention the words Annuity and ARF without understanding (or not being interested in) what they actually mean. So here goes.

When you retire your pension fund first provides you with a tax free lump sum. You will normally then have a choice between an Annuity and/or an Approved Retirement Fund (ARF).

An Annuity is a pension product where you buy an income for life in return for a once-off upfront payment from your pension fund.

There are various choices – and prices – of Annuity. A Single Life Annuity is payable for the rest of your life only. A Joint Life Annuity pays a percentage of your pension to your spouse after you die. A Level Annuity pays the same amount throughout your life while an Escalating Annuity pays an increasing payment amount throughout your life.

The drawbacks of an Annuity are …

  1. Once you take an Annuity, you lock in a rate of income for life. There’s no going back.
  2. If you live longer than expected, you’ve got a good deal. If not, the insurance company is the ‘winner’.
  3. Your stream of income ends when you die – there is nothing left to pass on.
  4. Right now a pension pot of €100k might buy you an annual €4k payment for life – twenty years ago you could have got twice this.

An ARF is a pension product where you can keep your money invested after retirement and decide yourself how much income to withdraw.

The advantages of an ARF are …

  1. You retain ownership of your pension pot – which is passed to your spouse / children /estate when you die.
  2. You control investment decisions and continue to benefit from tax free market returns.
  3. You also control income decisions, subject to certain conditions.
  4. You retain the option to buy an annuity later, which will pay a higher income as your life expectancy declines.

If you are comfortable with market risk and have significant resources, an ARF makes sense, but if you value the certainty and simplicity of a guaranteed income above all else, an Annuity makes sense –  or you can opt for a a combination of the two.

Try this Zurich ready reckoner but one way or another, you should talk to an independent financial advisor when you are about to retire, as choosing the right Annuity and/or ARF depends a lot on your personal circumstances and will significantly impact your retirement income.

 

Probate In Ireland

It’s not a subject we like to dwell on but it is important to know what happens to our money after we die. Knowing the processes involved (and how long they take) is a great motivation to structure our finances in a way that makes it as easy as possible for our beneficiaries to ‘get the money’.

Should I have a will?

In short, yes. If you do not, your money and property is distributed in accordance with the rules set out in the Succession Act. If you do have a will (which all of the following assumes) your estate will be divided according to your wishes by your executor (usually your next of kin or your solicitor). But that process can still be lengthy …

What is Probate?

On death (most) assets are frozen and a Grant of Probate is necessary to administer the estate. Taking out probate basically means having the Probate Office certify that the will is valid and that all legal, financial and tax matters are in order so that the executor can be allowed to get on with the job of distributing the estate.

How long does Probate take?

The process can be very lengthy (16 months on average!) and stressful so is best left to the solicitor. To get to the point of Grant Of Probate requires lots of forms, documents, interviews and of course a fee.

What then?

Once your solicitor gets the Grant Of Probate, distribution of assets begins, but only after payment of debts and taxes.

How can I make it easier?

The trick is to try to keep assets out of the Probate system. Married couples should hold joint current and deposit accounts (and joint investment accounts) as the surviving joint owner automatically owns the funds (on production of paperwork). Ensure all your insurance policies and pensions have correct next-of-kin information. Keep a copy of your will and a detailed statement of assets at home and at your solicitor’s office. And have a read of Money Matters After A Death from Citizens Information.

How Much Do I Need To Retire?

A question I get asked countless times is, how much do I need to retire? While there is no exact answer, and certainly not one figure that applies to everybody, there are two methodologies we can use to come to a conclusion.

 

The Salary Method

You’ll probably have seen various interpretations of this approach. There has been a traditional general assumption that most people/couples will need total pensions equivalent to two-thirds of salary. This two-thirds rule of thumb has been reached based on an assumption of lower spending in retirement. Some say that if the State Pension takes care of one-third of salary (that’s a big if!) then we should aim to build up private pensions that produce the remaining one-third of salary. I don’t like this methodology for two reasons, 1. Our current salaries may be too high or too low to act as a correct benchmark, and 2. Expenses are too important to be reduced to a secondary consideration.

The Expense Method

I favour this method as it’s far more likely to give you the correct answer (even if hearing it is not particularly comforting). Here we ignore salary and simply estimate what our annual expenses will be in retirement. I like the very user friendly Standard Life online calculator which tells me that my wife and I will face annual expenses of €50k living a comfortable but not extravagant retirement (I multiply the result for a single person by 1.6 to get the estimate for a couple).

So, How Much Do I Need To Retire?

In our case, if I subtract (one) €20k annual State Pension – which we can’t necessarily bank on – that means I will need a pension pot that can pay my wife and I a net €30k (let’s say a gross €40k) per annum all through retirement. Which means (I use a multiplier of 25) that we will need a total private pension pot of around €1 million to secure the retirement we want. Ouch!

That’s a big and scary number (and based on lots of assumptions about the future). Of course in reality, some of us will have additional capital (from non-pension savings or perhaps a property downsize) and some of us will maybe retire a bit later than planned. But the clear message for us all is that we really need to think very seriously about how much we need to retire and make every effort to maximise our pension contributions.

Need independent pensions and investment advice? Just call Money Smart on 01 276 0006 or email info@moneysmart.ie.

5 Easy Resolutions For The New Year

FireworksJanuary is a great time to set some good financial goals. However, to ensure you have every chance of sticking to these resolutions you should set small realistic goals. Here are 5 we recommend…

A is for Advice

First up, decide if you want to get independent financial advice or whether you want to go the DIY route. If you are going it alone, read on…

B is for Budget

Budgeting is the most important thing you can do to start you on the road to financial success. Many people make quite a lot of money but never have much to show for it because they do not manage their money well. The key is to know where all your money is going and then consciously plan where all your money should be going.

C is for Contributions

Once you’ve established a monthly or annual spending budget, the next step is to set up a savings plan that mops up any excess income. The best way to save is to automate the process, in other words, set up a direct debit to a deposit or investment or pension account.

D is for Debt

With the exception of low cost tracker mortgages, you should put in place plans to repay all debt, starting with the most expensive (usually credit card debt). As with savings, automate these debt payments to ensure you stick with the plan – you may have to make sacrifices along the way but it will be well worth the effort.

E is for Educate

As personal finance is not really taught in schools, we all have a responsibility to get to grips with the often boring and/or complicated world of money. Knowledge is power, but it could also be argued that knowledge is wealth because avoiding bad money decisions undoubtedly makes us richer.

Good luck and Happy New Year!

Please like our Money Smart Ireland Facebook page for free regular tips on how to be money smart.

Our First Big Money Mistake

Our big financial errors vary by age but a recent Wall Street Journal article highlights a big money mistake than young people are making today – they are not taking enough risk.

The table below is taken from that article and shows that millennials are holding as much as 70% of investible assets in cash. Several studies, not just this one, show people in their 20s playing it very safe by holding lots of cash in bank accounts and making extremely conservative investments.

wsj

 

Reasons for this vary but usually revolve around a lack of financial literacy and a failure to grasp the power of long term investing.  Of course the recent memory of a huge financial crash can only exacerbate investment caution. And there will be some who are rightly playing it safe as they save for a new home deposit.

Now for those unsure why they should invest aggressively in these early adult years, it mostly comes down to a single indisputable fact – the power of compounding.

The young have plenty of that most cherished investing resource – time. Being able to put money away for a long time creates the freedom to absorb the ups and downs of a multi-decade stock market investment. And it allows investments to compound over time – meaning dividends and gains are not extracted but are automatically re-invested year after year. Money doubles every 12 years with net 5% annualised gains. Which means the investment portfolio of a millennial should look more like 70% equities rather than 70% cash.

Learning this lesson by starting investing in equities as early in your life as possible can help sow the seeds for a lifetime of unworried investing and ultimately a very comfortable retirement.

How To Save

20-euroSaving money rather than spending it gives us no instant gratification but it is the road to eventual financial freedom. Here are some tips on how to get there.

Have a budget.

Make a note of exactly where your monthly income goes. Aim to have both a spending and saving budget and try to stick to it throughout the year. Motivate yourself by constantly reminding yourself what you are saving for – be it a house deposit, an education fund or a retirement fund.

Spend less.

If you want to spend less, the very first step is to pay attention to what you’re spending money on. Then think seriously about the necessity of everything you buy. Try to avoid impulse purchases by giving yourself the time to think carefully about whether you really need and can afford the item.

Avoid debt.

As a rule of thumb, all loans except your home mortgage are bad. So try not to take on any new debt and pay off your credit card in full every month. Keep a rainy day fund so that emergency expenses don’t end up on your credit card. And if you are in a position to pay off debt, focus first on the most expensive debt.

Isolate your deposit account.

The best way to save is to automate the process by setting up a direct debit to a deposit account. This creates a savings habit and will make you much less likely to reduce or stop monthly contributions. And mentally putting this account out of easy reach will help you avoid the temptation of raiding it in the short term.

Invest in your future self.

Financial planning is essentially about how we should allocate our money over our whole lives. For most of us, this means we must put some money away (in investments and pensions) for a time when we have no employment income. To put it simply, buying a Ford Fiesta now rather than a Ford Focus (and investing the difference) could mean your 70 year old self can drive a Lexus (rather than a Yaris!)

Need independent savings and investment advice? Just call Money Smart on 01 276 0006 or email info@moneysmart.ie.

Budget 2017 : 5 Key Takeaways

BudgetBudget 2017 has gifted us a range of ‘small sweeties’ but sees no major changes to how the government runs its finances (or controls ours). Here are 5 key changes – and what you should do about them.

1. Keep contributing to a pension

The State Pension may have been increased by €5 a week (whoopie doo!) but let’s not plan that Mediterranean cruise just yet. Much more importantly, continued pension contribution tax relief remains. It’s one of the last few meaningful tax reliefs so now is not the time to stop thinking about saving for retirement.

2. Pay off debt / Save more

A reduction in USC (and a few other very minor tweaks to tax credits) will result in us all seeing a little bit more money in our pocket. This may provide an opportunity firstly, to begin to pay off expensive debt, and secondly to save more. The DIRT (tax on savings) reduction from 41% to 39% is pretty irrelevant with deposit rates so low so once you have an appropriate emergency cash reserve you really do need to consider a higher earning medium to long term investment strategy.

3. Buy your first home

The controversial Help to Buy Scheme offers first time buyers a tax refund of 5% of the value of  a new home worth up to €600,000 but with a maximum rebate (from income tax already paid) of €20,000. Money Smart is a strong believer that you should own your own home (see our blog on this here) so this new incentive will hopefully help.

4. Maximise the value of your home

The Home Renovation Incentive Scheme has been extended for two more years. This popular tax credit effectively gives you full relief against the 13.5% VAT rate on home repairs or improvements.  On top of that, the very practical Rent a Room (Tax) Relief rises to €14,000 per annum, although Airbnb is excluded.

5. Think about your next of kin

While the rise in the parent to child inheritance tax threshold to €310k is welcome, the continued inclusion of the family home in the taxable estate and the unchanged 33% inheritance tax rate ensures that the many of us will also be passing on a very large tax bill to our children. Thus the need for financial planning advice on how to minimise this liability remains as important as ever.

Talk to Money Smart about a post budget personal finance audit by calling 01 276 0006 or emailing info@moneysmart.ie.

Pensions Made Simple (ish)

Pensions Made SimpleMade simple, really? OK maybe I’m setting the bar too high but I want to tell you all you need to know about pensions.

I’m bored already. Wait, this is important. Just give me 2 minutes of your time.

OK, go on then, why do I need a pension?  Because your income could drop to €12,000 a year if you only have the State Pension to rely on. That might pay for your annual cruise but not much else!

But I’ve got my work pension, right? If you’re in the public sector, yes. In the private sector only 6 out of 10 people have a work pension. Even then, most of us still won’t have enough, especially in the gap between retirement (55? 60?) and getting the State Pension (68?).

So I just need to put some money on deposit and watch it grow. Simple. Not so fast. Deposit rates are close to zero. You need to invest in a pension.

Why a pension? It’s too complicated. I know. Even the Bank of England chief economist says he can’t understand pensions. But he’s alright because he has a work pension that will pay him £80,000 a year. The rest of us mere mortals really need to invest for retirement in a pension – and the simple reason is tax relief.

Tax? Zzzzzzzzzzz. Stay with me.  If you contribute €100 to a pension the tax man gives you up to €40 back. So a €100 investment costs as little as €60 and it grows tax free until you retire.

Free money? There’s got to be a catch. No catch. OK you can’t touch the money until you retire but that’s a small price to pay for free money.

Yeah but I’m taxed on the money when I take it out! Yes but not much. The combination of being allowed to take a large lump sum tax free and the retirement income tax exemption means that most people end up paying minimal tax on retirement income.

OK but aren’t there lots of complicated rules about how I can actually get my hands on the money? You’ve got me there – that is true. But those constraints are being relaxed all the time. Now you can control your money in retirement and it doesn’t die with you (like it used to).

What about fees and charges? I’m probably going to get ripped off? Not if your financial advisor is on the ball. True it’s easy to hide all sorts of charges in complicated financial products but pensions are getting cheaper and much more transparent.

But hasn’t investment performance been rubbish? Ok yes in the bad old days some Irish pension companies thought a diversified portfolio was a Bank of Ireland bond, some Dublin commercial property and a shareholding in Anglo Irish Bank (doh!). Now you, or your financial advisor, can pick and choose your own globally diversified portfolio.

OK sounds like a good idea but how do I ‘get’ a pension? The paperwork alone must be a nightmare. Believe me, with the right financial advisor (ahem) it’s as easy as opening a deposit account. And the sooner you start the better. Over to you…

Call Money Smart on 01 276 0006 or email info@moneysmart.ie.

Ireland’s Pension Crisis

watching timeYou may have noticed (or hopefully missed!) various news headlines recently about the terrible state of pension coverage in Ireland.

Here’s a quick summary of the depressing facts.

  • The Chairman of the Pensions Authority said that what people expect to receive in retirement income is way out of line with what they will actually get. He said too few workers had pensions and many of those that have a private pension in place are putting too little into it.
  • Standard Life released research showing that the average person has only put enough into their pension to give them a weekly income of €60, excluding the State pension. Half of people want to retire to live in the sun or by the sea but the average person has only enough in their pension pot to give them a retirement income of €3,000 a year (excluding the €12,000 a year State pension) versus the (quite low!) €31,000 a year that those surveyed said they would need to live comfortably.
  • The Government’s Fuller Working Lives Report noted that once the public sector is excluded, six out of ten workers have no supplementary pension coverage. And over half of men and women have already stopped working before they reach State pension age.

Unfortunately the situation is only going to get worse. All of the above experts agree that the €233 a week State pension is not sustainable, pension investment return expectations are too high and the numbers of people with private pensions is actually falling.

Next month, we will turn away from this pretty grim big picture and take a look at what a private pension actually is, how to start one, why you need one and what you can do to avoid being an unfortunate statistic.

Inheritance Tax – What You Need To Know

New HomeWith the news that the new government may change inheritance tax rules, it’s worth pausing to consider what the current rules are, what changes could be coming, and what it all actually means for you.

The Definite Bad News

Not only has Ireland the highest ‘death taxes’ in the western world, in recent years increasing property prices, smaller families and lower exemption thresholds have combined to throttle unsuspecting Irish people with massive tax bills. If, for example, you are an only child who inherits the €800k family home, you owe the taxman 33% of the estate less the €225k exemption threshold. That’s an immediate tax liability of €190k you probably hadn’t bargained on.

The Possible Good News

The Irish Times reported on Friday that Fine Gael will raise the parent-child exemption from €225k to €500k so in the example above the tax bill would instead be €99k. A significant improvement for sure but that’s still quite a cheque to have to write (in reality most people in this position are forced to sell the inherited house to pay this bill).

What You Can Do To Reduce Your Children’s Tax Bill

  • Pass on property earlier, ie, before you die – the longer you leave it, the larger in value it grows and the larger the ultimate tax bill for your children.
  • If possible have your child move into the main home earlier – if they live there for 3 years before inheritance then the home becomes fully excluded from the taxable estate.
  • Consider a Section 72 Insurance Policy – specifically designed to pay inheritance tax.
  • Start annual gifting of up to €3k (per parent and per child / grandchild) – this is exempt from the tax.
  • Maximise threshold exemptions by spreading the inheritance among children, sons/daughters-in-law and grandchildren.
  • If you own a farm or a business, there are important exemptions you should know about.
  • Setting up a trust can in certain situations maximise tax efficiency.
  • Get married – passing assets to your spouse is tax exempt.
  • And finally, don’t forget to write a will.