Katie* was 35 years old and had just started a new job on a higher salary. She had begun thinking about buying a house within the next five years. She had a big short-term financial goal but wasn’t yet thinking about her long-term financial future. Her new employer automatically paid 5% of her salary into their employer pension scheme.
Katie attended an induction with her new employer and was invited to learn more about the company’s pension scheme. During training she learnt that starting a pension and making consistent contributions to it was one of the best things that she could do for her long-term financial protection. While her employer automatically contributed 5% of her monthly salary to her pension, she learnt that she could also make Additional Voluntary Contributions (AVCs) with which she could avail of 40% tax relief in her monthly paycheck.
Katie was shown an example of a 35-year-old and a 50-year-old contributing to their pension:
From age 35, if you were to contribute €100,000 over 30 years that would be €270 a month. After the tax relief, the contribution will only cost about €160 a month. Based on a potential annual return of 4.5%, this will result in a pension pot of about €202,000 at age 65.
If you were to start from age 50, investing the same €100,000 over 15 years with the same annual return of 4.5%, you would have a pension pot of €138,000 at the retirement age of 65.
Starting earlier makes a difference of roughly €64,000 to the final retirement pot amount.
Beginning a pension earlier also meant that if Katie had to take time off work for any reason and couldn’t contribute to her pension, she would still have a scheme that was working hard for her.
Katie was advised to aim towards having two-thirds of her current salary in her pension years. This assumed that she would have paid off a mortgage by then and may have some inheritance at that stage. However, her needs could increase depending on other costs including paying for a child’s education or house repairs. Katie took some time to settle on an annual income figure that she would like to have in retirement and worked backwards from that. Katie also included the state pension to her far future annual income but kept in mind that this number could decrease.
Working off her final income number, Katie decided to contribute Additional Voluntary Contributions towards her employer pension scheme. She put €270 towards it every month which only cost her €160 after tax relief. This meant she was still able to save towards a house deposit and eventually secure a mortgage without greatly impacting her day-to-day lifestyle.
As time went on through her 40s and 50s, Katie reviewed her monthly budget and was able to pay more towards her pension. She kept her contributions up and reviewed her pension progress annually. As her retirement approached, Katie moved her pension from high-risk investments to low-risk investments. At the time of her retirement Katie had managed to save more than the original two-thirds of her salary, but she had paid off her mortgage and had no other outstanding debt. When it came time to draw down her pension she took €200,000 of the full pot, which was tax free, and put the rest into a post-retirement fund.
Katie had to make the mental switch from saving towards her pension to now spending it carefully, but she tracked her monthly budget as usual and kept on course.
*Names have been changed to protect client anonymity.